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Drivers and Constraints for Adopting Sustainability
Standards in Small and Medium-sized Enterprises
(SMEs) and the Demand for Finance
Case studies from Brazil, China, India, Indonesia and
South Africa
Non-paper version, as delivered by authors
Christoph Sommer (Ed.)
Drivers and constraints for adopting sustainability standards in small
and medium-sized enterprises (SMEs) and the demand for finance
Case studies from Brazil, China, India, Indonesia and South Africa
Non-paper version, as delivered by authors
Published in cooperation with
Shanghai Institutes for International Studies (SIIS)
Fundação Getulio Vargas (FGV)
Indian Council for Research on International Economic Relations (ICRIER)
CII-ITC Centre of Excellence for Sustainable Development
Centre for Strategic and International Studies (CSIS)
DEFINIT
Tutwa Consulting Group
Bonn, 2017
© Deutsches Institut für Entwicklungspolitik gGmbH
Tulpenfeld 6, 53113 Bonn
+49 (0)228 94927-0
+49 (0)228 94927-130
Email: die@die-gdi.de
http://www.die-gdi.de
Contents
Abbreviations
Foreword
Peter Wolff
Introductory chapter 1
Christoph Sommer
I Drivers and constraints for adopting sustainability standards in small and medium-sized
enterprises (SMEs) and the demand for finance: a Brazilian case study 11
André Meyer Coelho & Marcelo de Oliveira Nunes (Fundação Getulio Vargas, FGV)
II Drivers and constraints for adopting sustainability standards in small and medium-sized
enterprises (SMEs) and the demand for finance: a Chinese case study 29
Dr CAO Jiahan (Shanghai Institutes for International Studies, SIIS)
III Drivers and constraints for adopting sustainability standards in small and medium-sized
enterprises (SMEs) and the demand for finance: an Indian case study (Part I: Macro
perspective) 45
Rajat Kathuria, Amrita Goldar & Sajal Jain (Indian Council for Research on
International Economic Relations, ICRIER)
IV Drivers and constraints for adopting sustainability standards in small and medium-sized
enterprises (SMEs) and the demand for finance: an Indian case study (Part II: Micro
perspective) 65
Shikhar Jain & Archith Ashok (CII-ITC Centre of Excellence for Sustainable
Development)
V Drivers and constraints for adopting sustainability standards in small and medium-sized
enterprises (SMEs) and the demand for finance: an Indonesian case study 93
Yose Rizal Damuri (Centre for Strategic and International Studies, CSIS)
& Bagus Santoso (DEFINIT)
VI Drivers and constraints for adopting sustainability standards in small and medium-sized
enterprises (SMEs) and the demand for finance: a South African case study 143
Peter Draper & Anna Ngarachu (Tutwa Consulting)
Foreword
Sustainability standards – voluntary or mandatory – have become a major issue in global
trade. Since SMEs are striving to integrate into global value chains the pressure to comply
to labor, environmental or governance standards has mounted. However, SMEs are facing
a multitude of barriers to adopt sustainability standards in their operations. The research
presented here sheds light on those barriers as well as on the incentives for SMEs to invest
in the adoption of standards. It also points to appropriate policy actions to be considered by
policymakers and stakeholders in support of SMEs.
The research is based primarily on case studies in five emerging economies – Brazil, China,
India, Indonesia, South Africa – which have been conducted by researchers from prestigious
research and advisory institutions from those countries. All of them are part of DIE’s
Managing Global Governance (MGG) network, a growing group of institutions in emerging
economies which is engaging in joint research, learning and policy outreach on global
issues. We are particularly pleased that initial results of this research have already been
taken up in G20 processes as well as by public and private standard setting institutions and
stakeholders in various countries.
The papers presented here provide ample opportunities for discussion as well as for further
research. We will continue collaborating on this and other topics in the MGG network,
reaching out to policy institutions and stakeholders. Many thanks go to the German Federal
Ministry for Economic Cooperation and Development (BMZ) for its continuous support and
to all partners who have contributed to this research project.
Peter Wolff
Head, Department World Economy and Development Financing
German Development Institute/Deutsches Institut für Entwicklungspolitik (DIE)
Abbreviations
ABNT Brazilian Association for Technical Norms
ACP Assets Certification Program (Brazil)
ADB Asian Development Bank
AEPC Apparel Export Promotion Council (India)
AFDB African Development Bank Group
AQSIQ Administration of Quality Supervision, Inspection and Quarantine (China)
AQUA Alta Qualidade Ambiental (Brazil)
ASEAN Association of Southeast Asian Nations
B2B business-to-business
BAB bank acceptance bill
BAD bank acceptance draft
B-BBEE Broad-based Black Economic Empowerment
BCI Better Cotton Initiative
BIS Bureau of Indian Standards
BNDES Brazilian Development Bank
BOB Bank of Beijing
BOC Bank of China
BSN National Standardisation Agency of Indonesia
CAA China’s Certification and Accreditation Administration
CAC Credit Advisory Centre (India)
CAFE Coffee and Farmer Equity
CAR Rural Environmental Registration (Cadastro Ambiental Rural, Brazil)
CASME China Association of Small and Medium Enterprises
CERFLOR Certificação Florestal (Brazil)
CFCS China Forest Certification Scheme
CFIE China Federation of Industrial Economics
CGS Credit Guarantee Scheme
CGTMSE Credit Guarantee Fund Trust for Micro and Small Enterprises (India)
CMB China Merchants Bank
CONAMA National Environment Council
CRE collectively-run enterprise
CRSCA China’s Responsible Supply Chain Association
CSIS Centre for Strategic and International Studies
CSR Corporate Social Responsibility
DTI Department of Trade and Industry (South Africa)
EITI Extractive Industries Transparency Initiative
EMS environmental management system
ERI Emission Reduction Investment (Indonesia)
ESG environmental, social and governance (principles)
EU European Union
EUR Euro
FDI foreign direct investment
FGI Investments Warranty Fund (Fundo Garantidor para Investimentos) (Brazil)
FGV Fundação Getulio Vargas
FIE foreign-invested enterprise
FSC Forest Stewardship Council
GDP gross domestic product
GIZ German Corporation for International Cooperation
GoI Government of India / Government of Indonesia
GOTS Global Organic Textile Standard
GRI Global Reporting Initiative
GVA gross value added
GVC global value chain
HQE Haute Qualité Environnementale (Brazil)
IBAMA Brazilian Institute of Environment and Renewable Natural Resources
ICBC Industrial and Commercial Bank of China
ICRIER Indian Council for Research on International Economic Relations
ICS International Classification for Standards
ICT information and communications technology
IEC International Electrotechnical Commission
IFC International Finance Corporation
IGO intergovernmental organisation
IISD International Institute for Sustainable Development
ILO International Labour Organisation
INDC Intended Nationally Determined Contribution
INMETRO National Institute of Metrology, Quality and Technology (Brazil)
INR Indian rupee
IPR intellectual property right
ISEC Subsidy Eligibility Certification Scheme (India)
ISO International Organization for Standardisation
ISPO Indonesia Sustainable Palm Oil
ITC International Trade Centre
ITC International Trade Centre
KfW German Development Bank
KYC know your customer
LPEI Indonesian Export Financing Institution
MNC multinational corporation
MNCs Multinational Corporations
MNE multinationalespecially when the certification is not directly linked to an
existing market opportunity. The high investments comprise both the adequacy to standards
and the auditing process per se. Typically SMEs need to hire consulting agencies and
qualified personnel to assist in the process, as they seldom have internal staff to go through
all stages, which increase even more the overall certification costs.
What has been seen as possible ways to overcome this problem is the issuing of group
certifications. This possibility allows small communities and owners of small forest
stewardship areas, for example, to be certified by sharing its implementation and auditing
costs. In some cases, the SME out of self-awareness adopt several of the practices usually
listed by certification agencies, but does not get certified because it cannot afford the
auditing costs. In other cases, the SME has previously had a certification, but fail to renew
it due to ongoing auditing costs, but still carry on with the sustainable practices. Depending
on the relationship with the lead company in the supply chain, in these cases the contract
with the small company can either be automatically terminated or not.
The problem concerning certification costs becomes even more prominent as one considers
the overall production costs in the country. According to specialists, Brazilian entrepreneurs
tend to face other barriers (monetary and non-monetary) that add up to operation costs that
are less observable in other countries, like the deficient logistics system, complex taxation
systems as well as the level of government’s bureaucracy. Just as an example, in average,
7.6 reports need to be filled in order to demonstrate companies’ state taxes alone. This
number can be up to 19 reports in some states.
Existing initiatives that are meant to surpass the costs barrier, like financing lines provided
by Sebrae, turns out being low in efficacy due to the next constrain concerning the
information gap.
B) Information and technical gaps
As one of the specialists from academia mentioned, the topic sustainability is not a new one,
and one may consider we are going through a second stage on the process towards achieving
a more sustainable global society. The first stage, in the early 1980’s was a time for people,
companies and governments to raise awareness on the topic and start reflecting upon
alternative ways for development. The second stage, the one the international community is
in, is a stage to commit to the cause and start witnessing concrete changes in the preservation
of resources.
Making a parallel to the reality in Brazil, SMEs seem to be starting to shift to the second stage,
as there is still too much misunderstanding on the relevance and feasibility of sustainable
practices. Despite the role played by the country internationally, since Rio 92, for instance, all
this talk and imperatives seem to be very distant from the small entrepreneurs’ day-to-day. It
is not clear for the majority of the SMEs their role in the process.
Even after overcoming this so-called raise of awareness stage, SMEs fail to identify which
possible paths could lead to being more responsible. There is a number of programs and
André Meyer Coelho / Marcelo de Oliveira Nunes
20 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
initiatives by supporting agencies that may be of help for SMEs. Sebraetec, just to mention
one of these initiatives, is geared towards the improvement of innovation in small
companies, covering topics such as design, productivity and sustainability among others.
According to consulters from these agencies, innovation sustainability projects are still not
very often seen in the proposals.
Finally, as SMEs raise awareness and learn about regulatory standards and VSS, they may
experience one final gap in the form of the necessary expertise. Usually high-qualified
professionals are demanded to adequate production processes, like environment engineers,
chemical engineers, agronomists, and so on. The technical terms and protocols stated in
standards usually require a degree of knowledge that goes beyond the ability of an average
SME to comply.
This is a very relevant issue that needs to be addressed, especially by standardisation
agencies when designing their products. Even after pricing and promoting certifications
adequately around the globe, when SMEs in developing countries have difficulties going
through the whole demands, it may lower the efficacy of these promotional efforts. How
much of this information asymmetry must be internalised by standardisation agencies,
supporting agencies, banks or the government is a decision open to discussion.
C) Scalability
A secondary problem associated with High costs concerns economies of scale. Usually, new
processes and technology are designed for big companies which, given their production and
service capacity, makes it more feasible to implement. SMEs not always have the scale
necessary to make certain processes financially and operationally feasible. A good example
is waste management. Even after reducing waste generation in the production process, there
will always be a portion of it that remains.
These residuals may be significant inputs for recycling processes within big companies.
However, there may be not sufficient ones generated by an SME so as to justify the
implementation of a new process or new technology to handle it within the company. On
the other hand, when seen jointly, waste and residuals from several SMEs may achieve the
necessary feasibility to a new production process, which can be seen as a market opportunity
to develop. Specialists believe that in order for this to happen, incentives on the
government’s side should exist.
D) Deficient supervision
SMEs who are engaged in GVCs are sometimes posed with communication problems with
the lead company. On the one hand, requirements by the lead are not always as clear as they
should be, for smaller companies to be able to coordinate the level of importance of each
practice and prioritise. Also, supervision of SMEs’ compliance on the lead companies’ side
is not always effective, which tends to lower the motivation of SMEs. Sometimes non-
compliant companies or companies with certification renewal pending may still be serving
as suppliers to the lead, as the termination of contracts is not always automatic.
Drivers and constraints for adopting sustainability standards in SMEs: a Brazilian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 21
5 In-depth analysis: cosmetics industry
Brazil is internationally known by its intense biodiversity. The country is home to 5 unique
biomes, among which the Amazon basin, that is covered by the Amazon Forest and accounts
for an area of about 6.7 million square kilometres. The region is populated by as much as
40 thousand species of plants, 300 species of mammals and 1.3 thousand bird species17,
which helps explain the widespread zoning of protected areas in its territory, including
national and state parks, ecological stations, biological reserves, wildlife refuges and other
typologies of conservation units as provided by Brazilian law.
As a means to capitalise the potential of such natural resources, there has been increased
interest by the cosmetics industry to develop products based on the Amazonian biodiversity.
Natura is a Brazilian company founded in 1969, based in São Paulo area, which has a
prominent presence in Latin America as a whole, in addition to its operation unit in France.
The company has an average yearly revenue of R$7 billion, employs over 7 thousand direct
workers and its main products comprise personal hygiene, fragrances and cosmetic items.
In a recent study carried out by UEBT (Union for Ethical BioTrade)18, Natura wasmentioned by 41% of Brazilian respondents as the brand perceived to make the most effort
to respect biodiversity in the country. That is explained by the company’s commitment to
several sustainable practices, many of which are described in its 2050 Sustainable Vision
document19. Just to mention a couple of initiatives involving packaging, for instance, since
1983 some product lines are offered in a refill format, and since 2007 the use of recycled
plastic for packages has been more widely adopted in different product lines.
Natura’s relationship with the majority of its productive suppliers (about 240) is managed
through its QLICAR20 Program. The initiative is aimed at leveraging the performance of the
value chain as a whole, by monitoring suppliers’ environmental, social and economic
indicators and promoting an exchange between smaller companies in terms of their
sustainable practices. In addition to the direct productive suppliers, Natura has a close
relationship with 31 rural suppliers, consisting of cooperatives, associations and SMEs.
As a whole, these smaller businesses involve 2301 families, most of which based in very
remote and difficult-to-access locations, which demands from Natura’s side an approach
that has been established over the past decades intended to develop these areas in terms of
infrastructure and business opportunities. In the present case study, we will focus on two
commodities used to produce fragrances, body lotions and oils: cocoa and priprioca root.
In 2004, Natura’s ISO 14001 certification process was completed, but even before that, in
2000, the company started a more thorough engagement process with its small rural suppliers
by implementing the Assets Certification Program (ACP). The program was possible after
Natura partnered with Imaflora, the Brazilian NGO responsible for providing Forest
17 http://www.icmbio.gov.br/portal/unidadesdeconservacao/biomas-brasileiros/amazonia
18 http://www.biodiversitybarometer.org/#country-results
19 Source: Natura Sustainability 2050 vision, available at: http://www.natura.com.br/sites/default/files/
static/sustentabilidade%20natura/visao%20sustentabilidade_2050_resultados%202014.pdf?utm_source=site
_cf&utm_medium=widget&utm_campaign=sustentabilidade
20 QLICAR = Quality, Logistics, Innovation, Competitiveness, Environment, Social and Relationship aspects.
André Meyer Coelho / Marcelo de Oliveira Nunes
22 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Stewardship Council (FSC) and Sustainable Agriculture Network (SAN) certifications in the
country. In 2010, about 36 bioassets, or 61% of the species used as inputs by Natura, were
certified. Certifications comprise FSC, SAN, IBD, ECOCERT, OIA and IMO labels.
According to small businesses (SMEs, cooperatives and associations) certified for Natura,
the main additional incentives, on the top of those flagged previously by the present study,
may be seen below:
1- Costs sharing. Natura covered, in many cases, the costs associated with obtaining
certification, these were mainly group certifications. In other cases, Natura would
partially subsidy the producers’ costs.
2- Higher margins. Natura sets prime prices for its suppliers who adequate their
productive systems to be certified.
3- No bonding contracts. Natura’s commitment to local development of its supplier
communities prevents it from demanding exclusivity contracts, this way it is possible
for small producers to diversify buyer if they wish so.
4- Genetic heritage. By taking part in Natura value chain, small rural producers are
entitled to receive benefits due to access of genetic heritage. Complying with law
#11.284/06, Natura transfers payments to family producers due to the exploitation of
traditional knowledge linked to local communities, and the access to bioassets and
genetic heritage. From 2000 to 2009, there has been a total payment of R$17.9 million
under these premises.
A synthesis of the main players (producers and processor) of small size in the Cocoa and
Priprioca value chain may be seen as follows.
Natura’s Cocoa and Priprioca Value Chain
Value Chain Producers Profile Productivity
Cocoa
IBC – Indústria Brasileira de
Cacau
Cocoa processor
-Since 2005
-34 workers
-R$3 million in revenue in 2010
900 tons/month
CABRUCA – Cooperativa dos
Produtores Orgânicos do Sul da
Bahia
Cocoa producer
-Since 2000
-39 workers
From 2005-2010:
-80 tons of cocoa sold to Natura
-R$550,000 in revenue
200 tons/year
Priprioca
(Cyperus
articulatus L.)
AMBVA – Associação dos
Moradores de Boa Vista do
Acará
APROCAM – Associação de
Produtores Rurais de Campo
Limpo
MMIB – Movimento das
Mulheres das Ilhas de Belém
APROCAM (Priprioca producer)
-Since 2002
-42 workers
From 2005-2010:
-135 tons of priprioca root sold to
Natura
-R$350,000 in revenue (R$3/kg)
42 tons/hectare
2011:
25,000 kg
R$3,96/kg
Source: Based on Carvalho, André P. Gestão sustentável de cadeias de suprimento: análise da indução e
implementação de práticas socioambientais por uma empresa brasileira do setor de cosméticos. Dissertation
(PhD) – Escola de Administração de Empresas de São Paulo, EASP-FGV, 2011.
Drivers and constraints for adopting sustainability standards in SMEs: a Brazilian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 23
6 Demand for finance
Concerning the Brazilian financial system to sustainability standards, little is known about
the control mechanisms set up by finance organizations in relation to the availability of
credit and the counterparts´ sustainability strategies and initiatives. An exploratory work on
financial possibilities to SMEs in Brazil will find several lines of credit available for
investments in general in small business. Either private or public banks open credit lines
without any specific commitment to sustainability measures, therefore, they do not capture
(yet) the possibility to use these processes to enhance the knowledge and practice of
sustainable activities from those taking the money. The credit lines are available in
differentiated rates, subsidised either by the government or under a risk investment of the
bank, betting on the strong Brazilian SME market and the need for financing.
As stated in the previous chapters, the use of sustainable patterns in the Brazilian market
(SME) is very much driven by the supply chain – major industries demanding certification
from their suppliers. In responding to this reality, the empirical evidence in this study
provided rich insights into the (lack of) use of the financial system for the improvement of
sustainability standards translating into proactive strategy for corporate sustainability
performance. In particular, the findings in this study allow us to understand the various
needs for financing in sustainability certifications in Brazil.
Unlike what was anticipated, higher interest rates did not emerge from the specialists’
interviews as a main problem for SMEs, as this seems to be a shared problem for entrepreneurs
in Brazil regardless of their company’s size. However, within the main setbacks when it comes
to credit access for SMEs, specialists highlight the difficulty to comply with terms and
conditions from financial institutions. Part of the requirements include longer years of
operation, which if we consider that in average 50% of SMEs do not survive past the first two
years of operation, it becomes clear how limited is the pool of potential companies entitled.
It is true that some specific financial products are designed for SMEs, however according
to specialists, even these ones are hard to comply, as collaterals may be of up to 130% of
the amount borrowed in some cases. It is recurrent in the specialists’talk, the impression
that SMEs lack alternatives, and that collaterals and general warranties should reflect better
the ability of SMEs to comply in a financially healthy manner.
The Brazilian Development Bank (BNDES) has credit lines to be taken by private and
public banks with differentiated interest rates based on segmentations stablished by the
organization. For example, they have open lines for microcredit and credit for SMEs that
are meant to enhance the business infrastructure or improve inventory management.
According to the governmental authorities interviewed in this paper, the rules for credit are
much more related to the development process than to a sustainability agenda. That does
not mean that the Brazilian government does not have a sustainable development agenda,
but the financial operations fail to match this agenda.
One specific example is the ABC Program 21– financing for investments that contribute to
the reduction of environmental impacts caused by agribusinesses. Its interest rates used to
be from 4.5% to 5% in 2015 and now they vary from 8% to 8.5%. It is granted by BNDES,
21 https://tinyurl.com/lt8egta
André Meyer Coelho / Marcelo de Oliveira Nunes
24 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
which may demand warranties of up to 130% of the amount financed. In the case of SMEs,
they offer the FGI22 – Fundo Garantidor para Investimentos23.
In the market banking system (in parallel to the development bank), the credit lines may be
accessed as a regular credit line either for SMEs or any other industrial part. They will
follow a regular risk assessment analysis and have competitive market rates. From credit
lines to investment in the agribusiness to industrial plant implementation, the opportunity
to take credit is not linked to a sustainability agenda, but, as previously mentioned, to a
developmental tendency.
Several reasons could be identified to highlight the need to a more focused agenda to
sustainability standards financing, making capital cost be more attractive for SMEs:
A) Command and control environmental norms
The environmental legislation in Brazil is relatively new and there is still a lot of effort from
federal, state and municipal governments to implement the law. Therefore, the firms prioritise
their attention to the rule of the law, which has already high costs to the entrepreneur,
especially the small and medium. According to entrepreneur associations, the production
sector in Brazil is mainly worried about operating under the law to avoid criminal
investigations and (therefore) are far from the incrementing of voluntary standards of
sustainability.
B) Lack of national incentives
In the process of research it is clear that the several departments of government and class
institutions are focused in policy making regarding sustainable standards. However, their
effort is not translated into a national platform for financing operational implementation of
sustainable patterns. For example, the sustainability reports under the Global Reporting
Initiative (GRI) are relevant instruments that a small number of companies present. At the
present moment there is lack of incentives to build up partnership agreements (especially
financial) that could facilitate the implementation of a national policy for reporting.
According to the class association authorities, most of the SME managers don´t have money,
time – or even good projects – to build up a strong network of reports.
C) Low pressure form the demand side
In addition to the possibilities of government invectives, there is a relevant aspect that
impacts the financing process as well. There is still in the Brazilian market a lack of
recognition of sustainability practices (including certifications) from those buying products
from SMEs. The consumers market for sustainable products is still very much concentrated
in a specific niche of the population. That makes the pressure for sustainable standards and,
consequently, for financing processes more discrete.
22 https://tinyurl.com/lwwpsky
23 FGI: Investments Warranty Fund
Drivers and constraints for adopting sustainability standards in SMEs: a Brazilian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 25
D) The lack of standard managerial processes for implementing proactive sustainability
strategy
This is a major impediment for SMEs achievement of sustainability performance, including
the ability to contract financing. Among entrepreneurs in Brazil, management may be
interested in investing in sustainability projects but unaware of how to execute them or how
to access credit lines. This increases environmental cost and risk and also the inability to
provide innovative products and services, such as environmentally friendly, green products.
E) The “culture” of certification for standards
While the few existing companies focus on extending their approach towards sustainability
strategy, the majority of SMEs only sees the environmental rules towards certifications. The
certification market is extremely relevant for the supply chain for internal and external
markets, but lines of financing and governmental agreements for the implementation of
Voluntary Sustainability processes could be strategic to the Brazilian market. That would
enlarge knowledge about sustainability industrial standards and create an additional culture
of voluntary patterns.
F) Segmented-financing lines:
There is no doubt that financing lines are relevant when they are applied to specific segments
of industry or agricultural sectors. However, in addition to the lack of governmental policy
there is a need to a broader financing line towards sustainability. Literature has proven that
the relationships among proactive sustainability strategy and corporate sustainability
performance are related to individual aspects of sustainability strategy and performance.
That means that if there is credit to invest in the sustainability approach as whole, the
company may increase the types of standards to be applied to sustainability according to its
objectives or to the knowledge of these managers (environmental strategy connected to
economic performance).
G) Knowledge production towards financing for sustainability is low
Most of the current sustainability strategy and certification studies that contribute to
understanding sustainability issues are qualitative, conceptual, and based on developed
sectors of the economy. According to the interviewees, only a few are quantitative and based
on surveys. This raises both contextual and conceptual concerns for financing: (i) the
opportunity to include local (country) knowledge in the (future) financing process; and (ii)
the opportunity to integrate international approaches to the country cases, creating relevant
information to the increment of sustainability standards in the supply chains.
The implementation of financing services under a strong public policy for sustainable
development could be a relevant mechanism to increasing the adoption of sustainable
standards either from certification of from voluntary approach. So far there is no horizontal
certification (even voluntary) in the agricultural, industrial or service sector in Brazil. The
present investments are much more related to a use of image or to the need to stablish levels
of certification to exportation or to sell to a bigger producer. A Sustainable financing
development strategy, which considers political aspects, environmental command and
control rules, economic and social aspects, must focus on maintaining environmentally
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26 German Development Institute / Deutsches Institut für Entwicklungspolitik(DIE)
friendly production processes for an indefinite future, but also in creating alternative lines
for sustainability standards in Brazil. In particular, this strategy aims at implementing
sustainability that benefits stakeholders and less-developed companies that contribute to the
supply chain in various ways.
7 Conclusions and recommendations
The adoption of sustainability standards is a reality to some of the SMEs in the Brazilian
territory. However, the great majority of standards are connected to certification processes
to comply with Global Value Chain patterns or to supply to major companies in the internal
market. Government institutions, business organizations, financial institutions and private
stakeholders, they all promote sustainable production processes and the need to adopt
compliance methodologies with social and environmental standards, but they operate with
introspective view. That means that every sort of organization in Brazil dealing with
sustainability standards is focuses in its own role instead of being part of a national policy.
To conclude, this study was able to find 4 key aspects that may be relevant to increase the
participations of SME in sustainability compliances and connect the several organizations
involved in a more cooperative way to promote best production standards. They will be
listed below as recommendations.
1. The need for a national governance network
The first and most important recommendation is related to the creation of a national
governance network for sustainability standards. The governance approach is necessary to
have a common agenda towards the implementations, the creation of financing lines, the
adaptation to command and control rules of law, to the disseminations of voluntary
sustainability standards and to simplifying the documentation processes to the operations of
SMEs. In a first approach the governance should be leaded by a federal organization, such
as a Ministry or Sebrae. It must be an institution with some sort of leadership, national
capillarity, but also capacity to drive a public policy towards a horizontal implementation
of sustainability standards of all kinds (mandatory, certified or voluntary).
2. Less bureaucracy
Brazil’s level of bureaucracy for businesses is an important gap to be overcome. The amount
of fees, documents and requirements that need to be provided in order for companies of all
sizes to operate is overwhelming. There are several different types of taxes. The “Simples
Nacional” was an advance, but still not enough, as several states and cities fail to implement
the same principles for taxes in their level. Considering sustainability is a branch of
innovation, when SME managers have so much bureaucracy to face, this topic gets
undermined and may fail to come forward in entrepreneurs’ agenda.
In Brazil, it takes in average 2 month to open a new company.
Every year entrepreneurs have (in average) 7.6 reports to fill out in order to demonstrate
their state taxes. That can be up to 19 reports in one of the states.
Drivers and constraints for adopting sustainability standards in SMEs: a Brazilian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 27
Initiatives in the federal level, like the Simples national, have been trying to minimize
the problem, but these initiatives need to be pursued by states and municipalities as well.
3. Creation of a supplier development program
Lead companies in GVCs face the burden of having to supervise its suppliers, which demands
the implementation of specific departments for accreditation of the standards stablished in the
supply chain. Throughout a broader policy for standards implementation those companies could
have specific financing from the government to improve their operations and adopt capacity
building processes among their suppliers to the implementation of certified standards.
4. Fund for SMEs to obtain certification
Companies, government and Certification institutions may create a fund to help SMEs and
small producers pay for the certification process. That fund could operate in parallel or
together the implementation of financing policies to sustainability standards in SMEs. That
would go hand in hand with the need to a more horizontal perspective of sustainability
standard implementation.
8 List of interviewees
Below, the list of specialists interviewed for the study can be seen.
Name Company Position
1 Alberto Besser FGV Professor and SME Researcher
2 Alexandre Ambrosini Sebrae Nacional Sustainability Analyst
3 André dos Santos Inmetro
Overcome of Technical Barriers
Division
4 Anízio Vianna Sebrae/MG
Innovation and Sustainability Access
Manager
5 Celso Lemme Coppead/UFRJ Professor and SME Researcher
6 Ellen Cavalheri Imaflora Forest Certification Coordinator
7 Laila Pieroni Martins
Brazilian Standards
Association/ ABNT
Market and events Manager
8 Leonardo Salema Inmetro
Cerflor Coordinator and Conformity
Analyst
9 Luis Fernando Pinto Imaflora Certification Manager
10 Mariana Garcia ABNT/AGS Senior Certification Consulting
11 Suênia de Sousa Sebrae/MT
Head of the Sebrae Sustainability
Centre
12 Valéria Barros Sebrae Social Business Specialist
13 Vana Tercia
Ministry of
Environment
Coordinator for environmental
standards
14 Vera Thorstensen FGV
Professor / Head of unit for
International Commerce
Drivers and constraints for adopting sustainability standards in SMEs: a Chinese case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 29
II Drivers and constraints for adopting sustainability standards in
small and medium-sized enterprises (SMEs) and the demand for
finance: a Chinese case study
Dr CAO Jiahan, Shanghai Institutes for International Studies (SIIS)
Introduction
Sustainability standards, which set best practice in an industry, can be effective tools for
verifying socially and environmentally friendly goods and services along global supply
chains. Some of these are set up by national government agencies as public standards to
provide legally binding requirements for general market access, while many others are
private standards, set up by multi-stakeholder initiatives or large companies with global
membership to attract segments of high-value market and respond to ethical concerns.
As an emerging power, China has become more prominent in global trade and investment
with both developing and developed countries. China’s embrace of sustainability standards
will not only promote the country’s overall competitiveness and new modes of low-carbon,
resource-light prosperity, but contribute to the transformation of global economy as well.
Always regarded as backbones of national economy, large State-Owned Enterprises (SOEs)
in China have become the primary focus of sustainability or Corporate Social Responsibility
(CSR) initiatives. It is important to engage with Chinese SOEs to enhance their
sustainability efforts, however, there is also significance to be aware of the growing needs
and obstacles faced by Small and Medium-sized Enterprises (SMEs) in working towards
sustainability. As the Chinese government has been committed to deepening domestic
reforms by giving more weight to market mechanisms, Chinese SMEs will be further
involved into the Global Value Chains (GVCs), which presents new opportunities and
challenges for the application of sustainability standards. When introducing, developing and
implementing sustainability standards in the Chinese context, it is necessary to improve
understanding of current endeavors by Chinese SMEs towards sustainability in GVCs, the
drivers of these endeavors, and their impact. In particular, what are the demands for finance
by Chinese SMEs to integrate into sustainable GVCs?
Built on an initial review of academicliterature and interviews with relevant stakeholders,
this report attempts to identify major drivers and constraints for adopting sustainability
standards by Chinese SMEs, with an analysis of those in the furniture manufacturing sector
in China’s Guangdong Province. In the meantime the report will explore the status quo of
financial services delivered to Chinese SMEs as well as their demands for better access to
finance that enable them to integrate into sustainable GVCs. The study concludes by
offering policy implications and recommendations how government, together with other
national and international stakeholders can take a leading role in promoting better
compliance with social and environmental standards by Chinese SMEs and facilitate their
access to finance.
CAO Jiahan
30 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
1 An overview of sustainability standards in China
It is currently lack of a clear definition on sustainability standards in China, while basically,
standards can be divided into public and private ones. The most prominent public standards
are regulations and “recommended” standards set by central and local government agencies.
Up until January 2018, 34015 active standards have been listed by the Standardization
Administration of China (SAC). Among these standards, 1995 are mandatory (marked as
“GB”) and 32020 are recommended (marked as “GB/T”) (SAC, 2018). Based on the
International Classification for Standards (ICS) formulated by the International
Organization for Standardization (ISO), SAC further splits the “GB” standards into 39
categories and the “GB/T” standards into 40 categories. None of these categories carries the
name of “sustainability standards”, and most of them encompass sector-oriented
performance, quality/safety and management standards. However, a large number of these
standards can be regarded as “sustainability standards” because of their nature. For instance,
one category of standards that is “environmental protection, health care and safety” (506
mandatory and 1176 recommended) may qualify as “sustainability standards” for they aim
at reducing socially and environmentally harmful impacts of technical products.
Notably, China’s Ministry of Agriculture (MOA), Ministry of Housing and Urban-Rural
Development (MHURD), Ministry of Environmental Protection (MEP) as well as National
Health and Family Planning Commission (NHFPC) play significant roles in formulating
public standards within their mandates to promote sustainability. Those standards made by
China’s MOA, MHURD, MEP and NHFPC, either mandatory or recommended, have yet
included into the SAC’s standard catalog. Nevertheless, they are considerably
sustainability-related due to their content. By June 2017, MOA has issued a number of
standards that concentrate on the process of food production and meet requirements from
consumers for higher food quality. MHURD lists 150 mandatory standards of energy
efficiency over the life cycle of buildings (marked as “JGJ”) and 173 mandatory standards
of urban sanitation (marked as “CJJ”) (MHURD, 2017). Similarly, MEP has issued 289
mandatory standards (marked as “GB”) and 95 recommended standards (marked as
“GB/T”), most of which are emission standards for vehicles and factories (MEP, 2017).
Furthermore, 535 standards on food safety and food additives are currently put in NHFPC’s
list, 255 of which are mandatory (marked as “GB”) and 280 are recommended (marked as
“GB/T” or “WS/T”)(NHFPC 2017).
Another class of public standards implemented in China derives from intergovernmental
organizations (IGOs), typically as the ISO and the International Electrotechnical
Commission (IEC). The ISO and IEC standards, like the ISO 9000 standards that define,
establish and maintain an effective quality assurance system for manufacturing and service
industries, the ISO 14000 standards that are related to environment management, and the
ISO 26000 standards that help organizations effectively assess and address social
responsibilities, have been adopted by the Chinese government and frequently referred in
the SAC’s standard catalog. For example in the mining industry, although China has rejected
the Extractive Industries Transparency Initiative (EITI), the Chinese government has given
its explicit endorsement to the ISO 26000 standards. Some Chinese companies, such as the
Aluminum Corporation of China, are employing the ISO 26000 standards as frameworks
for their CSR reports.
Drivers and constraints for adopting sustainability standards in SMEs: a Chinese case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 31
Besides these national and international public standards, we have also seen a rapid
expansion of private standards here in China, which generally belong to voluntary standards.
Many of these voluntary standards are set to address social and environmental concerns or
other sustainability issues along the GVCs and thus defined as voluntary sustainability
standards (VSS).
On the one hand, VSS set by western business giants and some international non-
governmental organizations (NGOs) have found their footholds in the Chinese market,
especially in forestry and agricultural sectors. A lot of corporate standards developed by
multinational corporations (MNCs) such as the IWAY standard of IKEA, Nature’s Choice
of TESCO and Filière Qualité of Carrefour, are introduced into China. Forest Stewardship
Council (FSC), Programme for the Endorsement of Forest Certification Schemes (PEFC),
Global GAP, Better Cotton Initiative (BCI), the Roundtable on Responsible Soy and
Roundtable for Sustainable Palm Oil (RTRS and RSPO), Fairtrade, the United Nations (UN)
Global Compact, the Global Reporting Initiative (GRI) and the Equator Principles, are
adopted by Chinese government agencies and companies to meet the demands of investors,
consumers and other stakeholders.
One example in this regard is the China GAP. China’s Certification and Accreditation
Administration (CAA) launched the China GAP series standards (GB/T 20014)
benchmarked to the Global GAP. The China GAP as a government project aims to set out
public voluntary standards for the certification of primary agricultural products (including
crops, livestock and aquaculture), which encourages reducing the use of chemical inputs,
with the aims of improving food safety, environment protection, worker health and safety
as well as animal welfare.
On the other hand, Chinese SOEs, industrial associations and some big private companies,
are leading the formulation of new VSS, which mainly target on textile, natural resources,
mining and manufacturing sectors. There are two conspicuous examples in this regard. One
is the Guidelines for Social Responsibility in Outbound Mining Investments, initiated by
China Chamber of Commerce of Metals, Minerals, Chemicals Importers and Exporters
(CCCMC), which has become the first standard to regulate overseas investment of domestic
enterprises in international mining sectors; and the other is China Social Compliance 9000
for Textile and Apparel Industry (CSC 9000T) set by China National Textile and Apparel
Council. In addition, China’s renowned information and technology (IT) company Huawei
is also promoting its Green Partner Initiative (GPI) as part of the company’s efforts on
fostering sustainability.
On November 4, 2017, China’s top legislature, National People’s Congress (NPC) passed
the revised Standardization Law which would bring implications for the future development
of VSS in China. Most importantly, VSS set by Chinese enterprises (e.g. Huawei’s GPI)
and industrial associations (e.g. CSC 9000T) are for the first time endowed with formal
legal status and thus acknowledged by the government. Meanwhile, the new law is set to
promote China’sfurther involvement in the formulation of international standards and the
adoption of international standards including VSS set by MNCs and other international
organizations. The new law also encourages participation of Chinese stakeholders including
enterprises, research institutions and NGOs in international standardization activities.
CAO Jiahan
32 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Although there is still no consensus on or special category for “sustainability standards” in
China, both the Chinese government and enterprises have increasingly recognized their
obligations to take social, environmental and governance issues into account when pursuing
economic benefits. Nowadays, the word “sustainability” is often used inter-changeably with
“Corporate Social Responsibility” or “CSR” by Chinese. The introduction of the concept of
CSR into China can be traced back to the 1980s right after the reform and opening-up
initiated by Mr. Deng Xiaoping, while it was not until 2000s that CSR came to be
understood and accepted by Chinese companies, largely because of regulatory changes
(Duan and Eccles 2014). The Chinese government amended the Company Law promulgated
in 1993 and put it into effect in January 2006, which officially adopted CSR as part of the
Chinese legal system. The Article 5 of the new Company Law encourages Chinese
companies to comply with laws and administrative regulations, social and business morality
when undertaking business operations, accepting the supervision of the government and the
general public and bearing social responsibilities (SCNPC, 2005). However, it is notable
that the Article 5 of the 2006 Company Law tends to be ambiguous for companies to follow
and thus far from legally binding in practice, though it has laid legal foundations for further
sustainable practices.
SOEs are key to CSR practices in China. In January 2008, China’s State-owned Assets
Supervision and Administration Commission (SASAC) published “Guidelines for State-
owned Enterprises Directly under the Central Government on Fulfilling Corporate Social
Responsibilities”, calling for Chinese SOEs to further promote the goals of CSR when
developing the Chinese economy, including workplace safety, protection of the legal rights
of employees, participation in social public welfare programs, protection of the environment
and conservation of natural resources (SASAC, 2008). Unlike SOEs, China’s SMEs do not
operate under a central supervisor, while the China Association of Small and Medium
Enterprises (CASME) is a significant stakeholder to provide CSR guidance to country’s
SMEs. On December 18, 2013, the CASME published the “Guidelines to Small and
Medium Enterprises on Corporate Social Responsibility”, the first document to instruct
Chinese SMEs to raise their CSR awareness and recognize four main categories of social
responsibility, namely employment, environment, market and community (CASME, 2013).
Under the framework of these CSR guidelines, CSR reporting is increasingly encouraged
by the government while still remains voluntary in China. Chinese governments in the
central and local levels have published a series of standards guiding businesses to release
their CSR reports. SAC issued a national standard in 2015 (GB/T 36001-2015) that sets
general guidelines for companies and other organizations expecting to develop and publish
a CSR report. It has laid out basic principles of reporting, key aspects of report planning,
steps for report compilation, and measures aimed at improving the credibility of a report
(SAC, 2015). Separately, stock exchanges in China are strong advocates of CSR reporting.
Since 2008, the Shanghai Stock Exchange (SSE) has been making and enforcing disclosure
requirements for listed Chinese and overseas companies. In particular, the release of
environment-related information has become mandatory for listed companies in the
extractive sector. The SSE also issued its environmental, social and governance (ESG)
reporting guidance, though it seems very broad in scope on how to report (SSE, 2008). In a
similar vein, the Shenzhen Stock Exchange (SZSE) published its ESG reporting guidance
in 2006, while its contents look more detailed. According to this guidance, listed companies
should report their implementation of CSR relevant to labor protection, environmental
Drivers and constraints for adopting sustainability standards in SMEs: a Chinese case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 33
impact, product quality and community relations. They also need to address public concerns
on measures and timetable for improvement (SZSE, 2006).
2 Incentives and challenges for Chinese SMEs to adopt sustainability
standards
It is widely acknowledged that definitions on a SME vary from country to country in the
world. The measurement of SMEs in China is mainly based on employee numbers, annual
revenue and assets, among other variables. According to the Categorizing Criteria for
Chinese SMEs enacted in 2011, the annual revenue of small-sized enterprises ranges from
3 million RMB (around 0.44 million US dollars) to 30 million RMB (around 4.36 million
US dollars), where employment size is from 20-300. The annual revenue of medium-sized
enterprises is from 30 million RMB (around 4.36 million US dollars) to 300 million RMB
(around 43.58 million US dollars), where employment size stays in between 300 and 2000.
Those enterprises with lower than 20 employees and less than 3 million RMB (around 0.44
million US dollars) annual revenue are considered micro-sized enterprises (MIIT, 2011).
By and large, SMEs have been playing a significant role in China’s economic and social
development. SMEs represented 98% of China’s all types of companies at the end of 2013,
and more than 75% of new products in China were created by SMEs that year (NBSC,
2013). According to another statistic by the World Economic Forum (WEF), SMEs of all
sizes in China contribute 60% of the country’s GDP and 73% of formal employment in 2015
(WEF, 2015). In 2012, China’s registered SMEs already accounted for 68% of the nation’s
export earnings (MOFCOM, 2012). A FedEx Corp. survey released in November 2015
showed that 45% of Chinese SMEs were then engaged directly or indirectly in export, 9%
above the regional average in Asia Pacific. Meanwhile, 61% of all Chinese SMEs surveyed
believed they would be generating higher revenue from international exports in next five
years (Fedex Corp., 2015). In China, nearly 70% of the SMEs are located in the eastern and
southern regions, while the rest are in the middle and western provinces. The third National
Economic Census (NEC) results demonstrate that the ownership of SMEs is skewing
towards private capital. SMEs in the Manufacturing, wholesale and retail sectors have hired
the majority of people and contributed more than 80% of the whole business revenue (Le &
Dong, 2014).
Therefore, the sustainability practice of Chinese SMEs should not be neglected, although
big SOEs are usually faced with tougher CSR pressures and have become major
practitioners of adopting VSS. Today Chinese SMEs are doing their business in a more
responsible and ethical way thanks to a series of incentives that include the change of
regulatory context, the involvement into global supply/value chains, the diffusion of
international VSS and etc.
The economic slowdown and environmental deterioration have compelled the Chinese
government to prioritize CSR as essential elements of transformation into new modes of
low-carbon and resource-light prosperity. Also, the implementation of the Paris Climate
Agreement and the UN 2030 Agenda has offered China both challenges and opportunities
to reshape its developmental pathway, which requires joint action from the country’spublic
and private stakeholders. With this background, Chinese SMEs have received mounting
pressures from the government to comply with recommended standards (“GB/T”) and CSR
CAO Jiahan
34 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
guidelines. Due to their voluntary nature, these standards or guidelines used to be adopted
by SMEs on the basis of self-determined principle, given different sizes and capabilities of
SMEs. In the past, the government basically focused on the economic achievements of
SMEs and companies that failed to comply with “GB/T” standards rarely faced
consequences. To balance economic growth and sustainability, the Chinese government is
now more inclined to push SMEs to fulfill their social responsibilities by absorbing CSR
measures into laws and regulations. For instance, China’s new Labor Law enacted in 2013
requires companies to compensate employees who are terminated unexpired labor contracts
at least 3-month salaries. Under the government pressure, an increasing number of Chinese
SMEs view concern and responsibility for employees as one of the most important aspects
of CSR. Moreover, products and services of good quality as well as environmental
protection and resource saving are other major aspects of CSR considered by some Chinese
SMEs.
However, solely from the perspective of Chinese SMEs, another two prominent drivers lie
behind their CSR practices and adoption of “GB/T” standards or even VSS. The first one is
to safeguard the public reputation or image of a company. Some researches show that
enterprises conducting their business more responsibly and ethically can increase their value
by managing public reputation and image (Li et al., 2013). Investigations on consumer
behavior also revealed that nearly 90% of customers would stop buying a product if they
learned any illegal or immoral practice on the part of the manufacturer. Customers are more
willing to buy a product with social and environmental benefits, even at higher prices (Ramli
et al., 2013). China’s booming market with rising demands from high-end consumers for
quality food and other commodities calls for certification and traceability services. Actually,
hundreds of thousands of small food processors in China have lost their market and even
gone bankrupt because of bad reputation on sanitary condition and labor rights. In this light,
more and more Chinese SMEs believe a well-known brand and a good reputation will keep
the loyalty of their existing consumers and attract more new potential ones, which is vital
for their long-term development. Therefore, they prefer to attend sustainability certifications
that guarantee the use of sound materials for making high-quality products. The
sustainability certifications also help them set criteria for a delicate control over their
processing procedure from raw material procurement, design to fabrication.
The second driver, the requirements of international customers and global market access,
are key factors that motivate Chinese SMEs to adopt sustainability standards or CSR
measures. For many Chinese SMEs, certifications of ISO 9000, ISO 14000 and ISO 26000
are deemed to be licenses for entry into the global market. Meanwhile, since a large number
of Chinese SMEs have become suppliers of MNCs such as Starbucks, Mars, Carrefour and
IKEA, they are encouraged to follow the practice of international VSS. For instance, IKEA
China requires all of its cotton suppliers to be certified under the BCI, and has been working
with Chinese SMEs to support the application of BCI (Blackmore et al., 2013). Therefore,
Chinese SMEs without international VSS certifications are likely to lose some of their
businesses as suppliers if they fail to pass the regular inspection by their international
buyers, while those whose products meet VSS have seen a dramatic increase of their export
volume (Alqahtani & Song, 2016).
Despite the incentives, Chinese SMEs have been constrained by a number of factors when
conducting CSR practices or adopting VSS. In the first place, China’s changing macro-
economy has prevented numerous SMEs, who are extremely sensitive to increases in supply
Drivers and constraints for adopting sustainability standards in SMEs: a Chinese case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 35
chain costs, from investing in their certification or CSR programs. The cost of certification
has long been considered a major challenge in the implementation of sustainability
standards (UNFSS, 2016). Under the current business circumstances with rising labor costs
and raw material prices, Chinese SMEs have no choice but to concentrate on how to survive
in low-price competitions so as to generate more profits, while sustainability certifications
and CSR programs could only lead to additional financial burdens (Alqahtani & Song,
2016). They are thus reluctant to adopt new practices unless many of their peers take actions.
Next, lack of financial support is also a major stumbling block to the CSR or VSS adoption
by Chinese SMEs (Alqahtani & Song, 2016). Compared with SOEs, SMEs in China are
beset by poor credit guarantee system, dearth of financial institutions supporting SMEs,
extremely high stock market threshold, and inability to obtain bank loans owing to imperfect
management and poor accounting system that discourages banks from lending to them. In
this scenario, Chinese SMEs will only have limited capitals to maintain their daily
operations, and make sure there are no payment delays or business downsizing. It is
imaginable that they cannot afford sustainability certifications without more financial
support.
Besides the difficult access to financial services, many Chinese SMEs are not fully aware
of the existence and significance of international, regional or even national standards. They
also lack technical and management skills to apply sustainability certifications (Graafland
& Zhang, 2014). A few SMEs are not equipped with testing, certification and accreditation
facilities while others are short of highly-qualified employees. The SME Competitiveness
Outlook 2015 by International Trade Center (ITC) shows that inability to conform to
standards has severely obstructed the access of SMEs to the GVCs, especially for SMEs in
some emerging economies (ITC, 2015). What’s more, the low consumer awareness of
sustainability in China, especially in less developed regions, also hinders the promotion of
CSR or VSS by SMEs, which demand more effective community engagement at the local
level (Alqahtani & Song, 2016). Most Chinese consumers seem to have little awareness of
the application, let alone the significance, of CSR or VSS, compared with those in some
European countries.
3 Furniture manufacturing SMEs in Guangdong: incentives for forest
certification
China is the largest furniture exporter in the world and enjoys a key position in the global
market of furniture products. Since furniture manufacturing SMEs usually rely on the resource
supply of timber, forest certification could enhance their market competitiveness and facilitate
their involvement into GVCs. FSC and PEFC, as two major international certification schemes
that account for around 98% of the world’s certified forests and chain of custody (CoC)
certificates, have been introduced into China. Also, China’s State Forestry Administration
(SFA) has developed the China Forest Certification Scheme (CFCS) whose certification scope
includes forest management, CoC, carbon forest, bamboo forest, non-timber forest products,
forest ecosystem services and commercially managed precious, rare and endangered species.
In this section, furniture manufacturing SMEs in China’s Guangdong province are chosen as
research samples to examine their motivations and incentives to adopt CoCcertificates.
Located in the Pearl River Delta adjacent to Hong Kong and Macao, Guangdong is regarded
CAO Jiahan
36 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
as one of China’s economic powerhouses. In 2014, the province’s GDP reached 6.779 trillion
RMB (about 1.104 trillion US dollars), an increase of 7.8% compared with that of 2013,
ranking No. 1 in the country. SMEs in Guangdong are significant as a major source of job
creation. The number of SMEs in Guangdong was 43.86 billion in 2014, which accounted for
more than 90% of enterprises and provided around 80% of the job positions (BSGP, 2014).
With its geographical advantages and industrial base, Guangdong has absorbed huge amounts
of foreign investment, and the development of furniture industry in the province is promoted
by the government. Thanks to relatively lower labor costs and higher productivity as well as
price advantages, a great many SMEs flourish in the furniture manufacturing in Guangdong
and have been expanding their international markets.
During March to April 2017, 21 managers from furniture manufacturing SMEs in Dongguan
City, Zhongshan City and Guangzhou City were contacted via telephone or e-mail.
Unfortunately, only 10 sales managers or heads of the marketing department agreed to be
interviewed, and most of them required to anonymize their names and companies. Among
these surveyed SMEs, 5 are foreign-invested enterprises (FIEs), 3 are private enterprises (PEs)
and 2 are collectively-run enterprises (CREs). Meanwhile, 7 are located in Dongguan City, 2
are located in Zhongshan City and 1 is located in Guangzhou City. In terms of business age,
6 enterprises have been operating for 5-10 years, 3 have been operating for less than 5 years
and only 1 has been operating for more than 10 years. In term of size, 1 enterprise (PE)
employs 45 people, 6 (including 1 PE, 2 CREs and 3 FIEs) have 50-100 employees, 2 (FIEs)
have 100-300 employees, and 1 (PE) has around 330 employees. Also, it is interesting to find
that 7 out of 10 surveyed SMEs, including 5 FIEs and 2 PEs, have chosen CoC certificates
with either the FSC or CFCS program, and the 3 enterprises (including 2 CREs and 1 PEs)
without any CoC certificates are all under age of 5. (See Table 1)
Table 1: Background of surveyed furniture enterprises
Location Ownership Number of
employees
Business
age (years)
Forest
certification
(with CoC
certificate)
Job title of interviewees
Dongguan FIE 165 12 Yes (FSC) President
Dongguan FIE 66 7 Yes (FSC) General manager
Zhongshan CRE 74 4 No Vice-manager
Dongguan PE 45 2 No Vice-manager
Guangzhou FIE 204 8 Yes (FSC) Director of Marketing
Department
Dongguan PE 330 6 Yes (FSC) Assistant manager
Dongguan FIE 93 8 Yes (FSC) Manager
Zhongshan PE 68 6 Yes (PEFC) Assistant manager
Dongguan FIE 82 7 Yes (FSC) Office director
Dongguan CRE 85 3 No General manager
Source: Interview summary by the author
More specifically, 3 FIEs and 1 PE who have adopted the FSC CoC certificates for a few
years are suppliers of MNCs such as IKEA and B&Q. As a founding member of FSC, IKEA
has very stringent procurement policies for wood products. With the long-term goal to source
Drivers and constraints for adopting sustainability standards in SMEs: a Chinese case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 37
all of its wood from well-managed forests as verified by a third party, IKEA has developed
the IWAY standard that set minimum requirements for environment and social & working
conditions when purchasing products, materials and services. To assure that suppliers are
meeting the IKEA code of conduct, the company demands that all suppliers must accept
reviews of the wood supply chain either by IKEA or a third party appointed by IKEA (FSC
is actually the only recognized third party), and will check all suppliers of wood products once
a year and do random audits of wood supply chains. Also, IKEA suppliers are responsible for
communicating the content of IWAY standard to their employees and sub-suppliers (IKEA,
2017). Therefore for the aforementioned SMEs, they must guarantee that their practices
strictly comply with business ethics which are requested and examined in a regular base by
these MNCs like IKEA. If they fail to do so, they are very likely to lose their qualification as
suppliers. As the manager of the PE mentioned, their company experienced a tough time after
IKEA demanded them to adopt the FSC CoC certificate, while they finally went through by
peer learning.
Furthermore, 2 FIEs who choose the FSC CoC certificates intend to use this as an effective
tool for international market access and a long-term strategy for expanding their international
market shares. In the global forestry trade, China plays a big role as processor and
manufacturer rather than an end market. Nearly half of the wood products processed in China
find their terminal market in the EU, U.S. and Japan, which increasingly require verification
that timber comes from legal sources. The amendment of the U.S. Lacey Act24 in 2008 and
the EU Timber Regulation in 2010 have further driven Chinese SMEs in the furniture industry
to adopt forest certification. Being foreign-invested nature with more than 80% of their
products exported to international markets, both of the two FIEs are very sensitive about the
changing regulatory context in the U.S. and EU. The FSC CoC certificate helps guarantee
their market access to western countries. As the manager of one company said, the export
volumes of their furniture to the U.S. have dramatically increased because of their
commitment to forest certification and FSC is just like a market passport for them.
In addition, the only PE who adopts the CFCS CoC certificate seems to have found some
hidden advantages of its furniture products in China’s domestic market. Unlike the 5 FIEs and
1 PE discussed above, this private enterprise sells the majority of its furniture products in the
domestic market and has been seeking great loyalty from domestic customers. China’s
thriving middle class and flourishing property market in the Jingjinji (Beijing, Tianjin and
Hebei), Yangtze River Delta and Pearl River Delta metropolises have driven the demand
for high-quality wood furniture products with forest certification. The manager of the PE
mentioned that their company has been facing growing pressures from local governments as
well as some NGOs in these developed regions to adopt more rigorous social and
environmental standards. Adopting the CFCS CoC certificate has provided the company with
enhanced opportunities for traceability on their furniture products which can differentiate
them from other competitors. From their perspective, this is also conducive to enlarging
market shares in western countries, since CFCS has received endorsement from PEFC in
2014.
24 The Lacey Act is a 1900 United States law that bans trafficking in illegal wildlife. In 2008, the Act was
amended to include plants and plant products such as timber and paper. This landmark legislation is the
world’s first ban on trade in illegally sourced wood products. Retrieved from
http://www.forestlegality.org/policy/us-lacey-act [08/04/2017].
CAO Jiahan
38 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
4 Financial services for Chinese SMEs to integrate into global value chains
Nowadays, global value chains (GVCs) have become more popular in the international trade
and investment system. According to a report released by the United Nations Conference
on Trade and Development (UNCTAD) in 2013, 80% of global trade takes place in GVCs
linked to transnational corporations (UNCTAD, 2013). The dynamics of GVCs have been
shaping a new organizationalsystem of production based on the precise division of labor
within industries and across countries, which can improve the production efficiency and
reduce the cost of manufacturing. Since the SME sector in China has been increasingly
integrated with global trade, Chinese SMEs that participate in the GVCs now include
material suppliers, parts and components suppliers, export oriented manufacturers,
subcontractors to MNCs, distributors and service sectors entering overseas markets. By
being involved in the GVCs, Chinese SMEs can obtain new technology, improve product
quality, enhance productivity and competitiveness, and as a result, expand their market
shares and create domestic jobs. While in the meantime, they may also face some barriers
such as labor market rigidity, cross-border regulatory constraints, non-tariff barriers and
poor access to finance. The Asia Development Bank (ADB) once estimated that the shortage
of trade finance in China and other Asian developing economies combined might have been
as high as 700 billion US dollars in 2014, and nearly half of trade finance requests from
SMEs are rejected (ADB, 2015a).
Although the Chinese government has formulated a series of policy frameworks to support
the development of SMEs, including the promotion of market access, technology transfer,
productivity enhancement, human capital development and improvement of business
climate, poor access to financial services still remains a structural problem for most Chinese
SMEs. Under the current financial system, Chinese SMEs are regarded as high-risk
borrowers and can only get very limited access to bank credit due to their lack of liquid
capital and real estate, which has become a major obstacle to their survival and growth.
According to the ADB, SMEs loans made up average of 18.9% of total bank loans in China
in 2014, only accounting for a small portion of commercial bank lending (ADB, 2015b).
Even if SMEs successfully receive credit from banks, their loans constitute a large part of
non-performing loans, which make banks even reluctant to lend them money.
To be further integrated into the GVCs, Chinese SMEs need to gain greater access to formal
financing and long-term funding opportunities. Actually, there is a clear demand among
Chinese SMEs for long-term funding of more than 5 years from formal financial institutions.
However, they have difficulty seeking appropriate financial options that meet their strategic
needs to participate in the GVCs, not only because of difficult access to bank loans, but also
because of no financial priorities, such as improving product quality and company
management, as well as how to deal with a rapidly changing business climate. Moreover, a
lack of knowledge about finance also prevents some of these companies from actively
exploring funding opportunities from diversified financing alternatives. In this light,
Chinese SMEs usually choose to rely on informal finance. Borrowing money from family
members, relatives and friends has been quite prevalent among SMEs in China.
Nevertheless, Chinese SMEs would still like to reduce their reliance on own capital and
informal financing channels. They’ve been looking for other financing models that go
beyond traditional bank credit, with a sharp increase in demand for venture capital
financing. In addition, Chinese SMEs requires more trade financial services to survive and
Drivers and constraints for adopting sustainability standards in SMEs: a Chinese case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 39
grow in the GVCs, given the rising costs of labors and raw materials as well as the dropping
profits.
Since most Chinese SMEs face challenges to manage their operating cash flow, supply chain
finance has become an increasingly preferred solution for SMEs financing from the
perspective of the entire supply chain. Supply chain financial services emerged around 2005
when Shenzhen Development Bank (now the Ping An Bank, PAB) introduced the “1+N”
model in view of lack of funds of domestic logistic companies. The “1+N” model usually
seeks a large core business in the supply chain as the starting point to provide financial
support, and then links the core business with upstream and downstream SMEs. On the one
hand, funds from banks will be effectively injected into SMEs through shared credit with
the core business, helping them solve financing difficulties and improve the balance of the
supply chains, while on the other hand, banks’ credit will be integrated into the purchase
behavior of upstream and downstream SMEs, promoting them to establish long-term
strategic synergy with the core business to enhance competitiveness of the whole supply
chain.
The “1+N” supply chain finance model soon attracted other major commercial banks,
including Industrial and Commercial Bank of China (ICBC), Bank of China (BOC) and
Shanghai Pudong Development Bank (SPD Bank), etc. These banks have begun to realize
that giving SMEs financial support is not only the demand of national policies but also the
requirement of expanding market shares and cultivating new sources of revenue. They thus
quickly stepped into the field and upgraded their services into e-supply chain finance with
the ongoing development of internet-based economy in China. For instance, ICBC now
provides loans through electronic banking channel to upstream and downstream companies
in a supply chain, who transacts with some key companies of the supply chain via e-
commerce websites. ICBC extends credit to the upstream and downstream companies in a
supply chain based on their online transactions, commercial credit record and credit
standing of the key companies (ICBC, 2017).
Despite its features and advantages, ICBC’s e-supply chain finance still requires the banks
to facilitate SMEs to get funding based on the credibility of “core business” or “key
companies”. However in practice, domestic banks usually enlarge the credit of “core
business” to support more enterprises in the supply chain. Therefore, if the core business or
large enterprises have 10 banks to conduct similar credit, their credit will be extended 10
times, which may lead to a dramatic credit expansion in the foreign trade. Furthermore,
since SMEs usually lag behind large “key companies” in employing the Internet in order to
reduce the cost, they have relatively lower transparency of activities in the supply chain
process. Banks sometimes refuse the financing request from SMEs even within the supply
chain for they cannot monitor the business of SMEs in real time.
To solve these problems, non state-owned commercial banks like PAB and China
Merchants Bank (CMB) are moving faster than those state-owned ones in innovation. PAB
has developed a new online supply chain finance platform named Orange-e-Net, which
represents the evolution of “1+N” model into “N+N” model. Instead of relying on the
credibility of “core business” or “key companies”, Orange-e-Net is set to deliver financial
services directly to a variety of SMEs based on their real-time transaction records. In
collaboration with some third-party information platforms, Orange-e-Net has been able to
provide affordable e-commerce services for these SMEs which can better promote their
CAO Jiahan
40 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
synergistic coordination of production in the supply chain. In another case, CMB has
introduced its Business-to-Business (B2B) bills pool service into Alibaba’s e-commerce
platform, which collects the bank acceptance bills (BABs), also known as bank acceptance
drafts (BADs), from large companies on Alibaba’s platform. In the past, e-commerce B2B
platforms allowed only cash payments between two parties, which is not a common practice
adopted by large companies. CMB’s B2B billspool service makes non-cash payment from
conglomerates to SMEs possible. By uploading BABs onto Alibaba’s platform, SMEs are
able to quickly receive payments via CMB’s acceptance bills with a corresponding amount
of funds without pledging any assets. To activate the B2B bills pool service, Alibaba
member companies only need to submit an application form with additional documents
demanded by CMB (Hong & Yu, 2017).
Currently, there are very few Chinese banks that provide tailored financial services to
promote adoption of sustainability standards by SMEs, and also, there seems to be a lack of
relevance between sustainability compliance by SMEs and their easier access to formal
financing or long-term funding opportunities. Nevertheless, it is notable that the Bank of
Beijing (BOB) has become the first Chinese bank to include a water-efficiency component
under a risk-sharing facility with the International Finance Corporation (IFC). In the past
few years, BOB has been working with IFC’s China Water Program to finance Chinese
SMEs in the textile industry to improve water efficiency and water quality, which set an
example for future cooperation between international and local financial institutions to
facilitate SMEs with sustainability compliance in emerging economies to get access to
finance and thus promote more sustainable production process.
5 Policy implications and recommendations
So far, it can be concluded that the adoption of sustainability standards by Chinese SMEs
still remains in its infant stage. On the one hand, more and more CSR measures or even VSS
have been included into laws and regulations, which SMEs are increasingly obliged to
conform to. Some SMEs choose to take an active part in sustainability certifications based
on their intrinsic needs to safeguard market reputation or status as suppliers to MNCs; while
on the other hand, a great many SMEs fail in standards compliance due to various
constraints such as price sensitivity and rising costs, lack of technical, management and
financial capabilities, as well as the low consumer awareness. As the first step, mapping out
drivers and constraints behind company behaviors could help come up with potential
solutions.
From a much broader perspective, the UN 2030 Agenda has set parallel objectives to
simultaneously promote sustainability and trade. It is notable that the Sustainable
Development Goal (SDG) 12 aims at ensuring sustainable consumption and production
patterns, while the SDG Target 17.10 calls for a universal, open, transparent, predictable,
inclusive, non-discriminatory and equitable multilateral trade system under the World Trade
Organization (WTO) (UN, 2015). However in reality, it will not be an easy task to kill two
birds with one stone. In terms of sustainability standards, they can be conducive to
facilitating the transformation of consumption and production patterns, meanwhile they also
trigger some concerns about creating barriers to trade. Therefore, it is worth thinking how
to guarantee the adoption of sustainability standards by SMEs will not sacrifice their trade
Drivers and constraints for adopting sustainability standards in SMEs: a Chinese case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 41
interests. Sustainability standards should never become trade barriers or job killers that
jeopardize the basic survival of SMEs. Instead, they should be used as effective tools to
foster true sustainability and better employment and contribute to socially and
environmentally sustainable economic growth in the long run.
To this end, the Chinese government shoulders an indispensable responsibility in navigating
SMEs through their difficulties in standards compliance. Given China’s centralized political
culture and authoritative traditions, government at all levels needs to take the lead in scaling
up their efforts on capacity building for SMEs. The inability of Chinese SMEs to adopt
sustainability standards can be well addressed through the combination of tax stimulation,
bank financial support as well as technical and management assistance from the
government. In particular, the launch of China’s national platform on VSS in June 2017 has
presented a unique and valuable opportunity for SMEs to embrace sustainability standards.
By absorbing experts from relevant ministries, industries, academia and NGOs into the
advisory committee, China’s national VSS platform could follow trade discussion and
conduct sector-based investigation as well as impact assessment on SMEs’ access to the
GVCs. It could also provide SMEs concrete capacity-building or training projects to directly
support their participation in VSS activities and indirectly strengthen their competitiveness
in international trade. Furthermore, China’s national platform should establish a VSS
database in partnership with ITC to deliver tailored information services to SMEs and
improve their understanding on complicated standards systems. Finally, China’s national
VSS platform needs to hold regular dialogue with its counterparts in other developing
countries such as India and Brazil to share experience and lessons and pave the way for
mutual VSS recognition in the future. The SAC, under the guidance of Ministry of
Commerce (MOFCOM) and Administration of Quality Supervision, Inspection and
Quarantine (AQSIQ), should continue to be proactively engaged in mutual learning and
knowledge exchange activities coordinated by the United Nations Forum on Sustainability
Standards (UNFSS) and German Development Institute (DIE-GDI) to enhance China’s
national VSS platform.
In addition to efforts by the government, large Chinese private companies, especially these
electronic commerce and trade platforms, also possess key positions in promoting standards
compliance by SMEs and meet their demand for finance. China’s e-commerce giants
represented by Jack Ma’s Alibaba Group, can leverage their great influence to cultivate
consumer awareness on sustainability standards and innovatively extend green digital
finance to SMEs based on big data analysis. It is worth mentioning that Maritime
Stewardship Council (MSC) has been in collaboration with Alibaba Group to promote sales
of MSC certified fishery products on the Tmall platform which brings extremely positive
market responses to seafood sustainability certifications. IFC has also reached consensus
with Alibaba’s Ant Financial Services to strengthen their cooperation on joint investments
to make digital finance more accessible to Chinese SMEs.
For international standards-setting bodies, either IGOs, NGOs or MNCs, it would be better
to get government endorsement which could make sustainability standards more acceptable
by Chinese consumers and SMEs. However, this by no means implies that international
stakeholders cannot survive only if they degrade their standards to reach compromise with
the government. They should rather be encouraged to initiate consultation with the
government to further improve existing official certification programs. More importantly,
CAO Jiahan
42 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
they should work closely with the government to develop more coordinated, localized and
sector focused certification programs to better facilitate the inclusion of SMEs to the GVCs.
These programs should stay as rigid as possible while taking an incremental and
differentiated approach to include SMEs on the basis of their capacity progress.
Drivers and constraints for adopting sustainability standards in SMEs: a Chinese case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 43
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Drivers and constraints for adopting sustainability standards in SMEs: introductory chapter
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 1
Introductory chapter: The growing importance of standards1
Christoph Sommer, German Development Institute / Deutsches Institut für Entwicklungspolitik
Over the last decades, globalisation has led to the continued internationalisation of
production processes. Production has become fragmented and dispersed across countries
with multiple firms contributing intermediate inputs to the final good. These complex
production networks the global value chains (GVCs) have fostered the relevance and
spread of standards for several reasons: Civil society organisations try to make production
more transparent through the certification and labelling of products and services that comply
with social and environmental standards in order to make conscious consumption decisions
possible. Large corporations, as lead firms of GVCs, make use of standards to steer and
organise their vast supply chains and ensure the quality and compatibility of the supplied
inputs. In addition, standards compliance allows lead firms to manage brand reputation and
to access high-value segments of the market, for instance, for ethical and organic produce.
While standards were initially concerned with quality and the compatibility of
intermediaries, they have increasingly included an orientation towards the production
process to account for consequences for workers, the local community, and the environment
– starting in the late 1990s. The rise of sustainability standards is welcomed in the political
sphere as social and environmental standards contribute to the achievement of the 2030
Agenda, in particular to Sustainable Development Goal (SDG) 8 (decent work and
economic growth) and SDG 12 (sustainable consumption and production patterns). In order
to foster sustainable supply and global value chains, social and environmental standards
have been prominently integrated into the latest leaders’ declarations of the G7 and the G20.
However, transformative effects will only materialise if sustainability becomes mainstream
in entire industries and sectors, which in turn requires that standards become both credible
through their positive social and environmental effects as well as bearable in that their
financial and nonpecuniary burdens for firms in the supply chain are acceptable (IAWG
[Inter-Agency Working Group], 2011). The latter prerequisite is at the core of this collection
of case studies, which look into the drivers and constraints for small and medium-sized
enterprises (SMEs) to adopt sustainability standards. Before the five country case studies
from Brazil, China, India, Indonesia, and South Africa are presented in full length, this
introductory chapter provides a definition and an overview of social and environmental
standards and briefly sketches the growing importance of GVCs and sustainability as well
as associated opportunities and challenges for SMEs.
Origin and classification of standards
Most standards that are listed by national metrology institutions, national standard-setting
bodies, the International Organisation for Standardisation (ISO), and other standard
organisations are of generic nature. These standards entail agreed-upon technical norms in
order to ensure quality and compatibility of products and processes. The following case
studies, however, focus on a specific subgroup of standards that are broadly defined as “…
set[s] of criteria defining good social and environmental practices in an industry or product”
1 This introductory chapter draws heavily from and incorporates extracts from Sommer (2017).
Christoph Sommer
2 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
(ISEAL, 2017). These social and environmental standards are also referred to as sustainability
standards in this publication.
To get an overview of the complex standard landscape, standards can be organised along
meaningful dimensions. The probably most elaborate and comprehensive typology of
standards is presented by Nadvi and Wältring (2004). Their typology differentiates
standards along the seven dimensions presented in Table 1.
Table 1: Typology of standards
Scope Function Geographical
reach
Key
drivers
Forms Coverage Regulatory
implications
Process
standards,
product
standards
Social, labour,
environmental,
quality, safety,
ethical
National,
regional,
international
Public,
private,
public-
private
Management
standards,
company
codes, labels
Generic,
sector
specific,
firm/value
chain
specific
Legally
mandatory,
necessary for
competition,
voluntary
Source: Based on Nadvi and Wältring (2004)
Since the focus of this paper is on social and environmental standards, the first two
dimensions are already fixed: interest lies in the social and environmental performance
(function) during the production process (scope). The dimensions of “coverage”, “forms”,
and “geographical reach” are merely of a descriptive nature for the formal anchoring and
the spread of standards. For the sake of simplicity, the main focus will thus be directed
towards the two central dimensions that also influence the other dimensions of the typology:
the key players behind the standards and65-79.
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Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 45
III Drivers and constraints for adopting sustainability standards in
small and medium-sized enterprises (SMEs) and the demand for
finance: an Indian case study (Part I: Macro Perspective)
Rajat Kathuria2526, Amrita Goldar27 & Sajal Jain28, Indian Council for Research on
International Economic Relations (ICRIER)
Abstract
This paper looks at the current status of sustainability standards among Micro, Small and
Medium Enterprises (MSMEs) in India. Given the MSME sector’s economic and social
importance, it is crucial that this sector be directed towards more environmentally benign
developmental trajectories. Diseconomies of Scale and technological backwardness have
often plagued this sector, with lack of access to formal sources of finance being the result.
The following paper tries to look at how greater integration into global value chains and
financial innovation for the MSME sector could be brought about and how these could
thereupon be used for achieving the aforementioned desired sustainability outcomes.
1 Background
Worldwide, micro, small and medium enterprises (MSMEs) have been recognised as
engines of economic growth. MSMEs have been instrumental in generating large-scale
employment; contributing towards rise in incomes of labour and returns to capital; promoting
regional development; etc. In India the Micro, Small and Medium Enterprises (MSME) sector
forms a pivotal part of the Indian economy. These enterprises are a product of individual skills
and initiatives, displaying high operational flexibility, tendency to adapt to technological
innovations, and utilization of local human capital and material resources to the optimumlevel.
According to the Ministry of MSME, these enterprises contribute around 38% of the national
GDP, 45% of the overall exports and 40% of the national industrial output. (CII, 2016).
According to the Annual Report of Ministry of MSME (2015-16) (MSME, 2016a), there
are about 51 million MSMEs in India, employing over 117 million people, making it the
second largest employer in India after agriculture. There are over 7,000 products, ranging
from traditional to high-tech, that are manufactured by Indian MSMEs today (FMC, 2016).
In India, MSMEs are defined in accordance with the provision of the Micro, Small &
Medium Enterprises Development (MSMED) Act, 2006 and are classified into two classes
based on investments made:
25 Corresponding Author
26 Director and Chief Executive, Indian Council for Research on International Economic Relations
(ICRIER), Core 6A, 4th Floor, India Habitat Centre, Lodi Road, New Delhi-110003
27 Fellow, ICRIER
28 Research Assistant, ICRIER
Rajat Kathuria / Amrita Goldar / Sajal Jain
46 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Manufacturing Enterprises: Enterprises engaged in the manufacture or production of
goods pertaining to any industry specified in the first schedule to the industries
(Development and Regulation) Act, 1951. A Manufacturing Enterprise is defined in
terms of investment in plant and machinery.
Service Enterprises: Enterprises engaged in providing or rendering services and are
defined in terms of investment in equipment.
The categories of different MSMEs are shown in Table 1 below.
Table 1: Categories of MSMEs
Industry
Category
Investment in plant and machinery/ equipment (excluding land and building)
Manufacturing enterprise Service enterprise
Micro Not exceeding INR 25 lakh Not exceeding INR 10 lakh
Small Between INR 25 lakh and INR 5 crore Between INR 10 lakh and INR 2 crore
Medium Between INR 5 crore and INR 10 crore Between INR 2 crore and INR 5 crore
Source: MSME (2016a)
The 4th All India Census of MSMEs for 2006-07 is the most comprehensive source of
information on the MSME sector with its coverage of 24 lakh units from the registered sector,
and more from the unregistered sector (MSME, 2011). The data from this survey shows that
Micro enterprises dominate the MSME sector with a 94.9 per cent share, followed by small
enterprises (4.9 per cent) and medium enterprises (0.2 per cent). Geography wise, around 45.2
per cent of enterprises operate in rural regions. On activity basis, firms can be classified into
three categories: manufacturing (67.1 per cent of total registered units), services (16.8 per
cent), and repair and maintenance (16.1 per cent) (IBEF, 2013).
Key MSME product categories in India in terms of employment, turnover, GVA and exports
are presented in Table 2 below. In view of their importance, it is clear that any policy
directed towards sustainability goals needs to necessarily target these key sectors.
Table 2: Ranking of sectors as per contribution of MSMEs
Census-sectors Employment Turnover GVA Export
Food products and beverages 1 1 1 2
Textiles 2 2 2 3
Wearing apparel 3 7 6 1
Fabricated metal products 4 5 4 6
Chemicals and chemical products 7 4 3 5
Machinery and equipment, n.e.c. 6 6 5 7
Basic metals 9 3 7 10
Other non-metallic mineral products 5 10 9 9
Source: MSME (2011)
The paper is organized in the following manner. Section Two discusses the status of
production networks in India and the G20 Working Group context that promotes integration
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 47
of MSMEs into Global Value Chains. The following Section (Section Three) discusses the
taxonomy of existing sustainability standards in India. Standards are looked at both from the
vantage points of environment (local pollution and climate change) as well as social welfare.
Section Four looks at the benefits from and barriers to greater adoption of sustainability
standards in India. The situation with respect to access to finance is discussed in the next
section (Section Five). The last section presents the conclusions where we discuss how both
finance and GVCs could be leveraged to encourage firms towards sustainability standards.
2 Economic clusters and integration into global value chains
The MSME landscape has matured over time and moved up the value chain. The MSME
sector has evolved from the manufacturing of traditional products to much more hybrid
products to the value-added services segment. This transition has been majorly fuelled by
the consortium approach adopted by MSMEs.
The organization of MSMEs into homogenous clusters has been a historic phenomenon.
Abid Hussain Committee on Small Scale Industry, set up by the then Ministry of Small
Scale Industry, in its report in 1997 was first to recommend adopting the cluster approach
for support to small and medium enterprises. Firms in the MSME sector that were facing
difficulties in achieving economies of scale, specialisation and innovation due to their small
size have all benefited from the advent of industrial clusters. Clusters and associated
networks enable small firms to combine the advantages of running a small unit, with the
benefits of scale and specialisation provided by large units. Even access to finance is a bit
easier for units as financial institutions such as banks have prior details of the production
processes and business requirements through past transaction histories and can plan
appropriate credit instruments and delivery mechanisms, thereby reducing operational costs
for both parties. Currently, there are more than 600 industrial SMEs clusters and over 7,000
artisan/micro enterprise clusters operating in India (IBEF, 2013). FMC (2016) estimates that
around 63% or about two-thirds of Indian MSMEs operate from industrial clusters.
Albeit its domestic market orientation, the networking approach in economic clusters has
helped MSMEs to overcome barriers such as technological obsolescence, supply chain
incompetence, global competition and investment shortages. It is expected that with greater
international integration with various product global value chains the level of specialization
would only increase.
For developing countries such as India, it is generally easier to enter a value chain as a
lower-tier supplier. But this position tends to be unstable as the SME can be easily replaced
by other suppliers that offer better comparative advantages, such as lower costs of
production (Abonyi, 2005). Thus, there become two goals that need to be targeted
simultaneously. First, to try to enter a global value chain, and, second, to move up the tiers
by upgrading the added-value content of their activities. Existing studies such as by Harvie
et al. (2010, 2015) focus on identifying key factors that are important for SME participation
in a regional production network, and then key factors influencing the participation of SMEs
in higher value-adding tiers of a production network for seven ASEAN economies plus the
PRC. They found that the key factors associated with the ability of SMEs to participate in a
production network were labor productivity, foreign ownership share, financial stability and
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48 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
cost of credit, and an ability to meet international standards of their goods. Integration of
ICT as a core part of their business activity was also found to be important.
The importance of promoting SMEs and integrating them into global supply chains as a
driver of sustainable development has been recognized at the 2016G20 Summit in
Hangzhou as well. This work on “implementation of the G20 Action Plan on SME
Financing” would continue under the 2017 German Presidency and investigations would be
conducted in order to find out how innovative financing models may promote the integration
of SMEs into sustainable global supply chains.
3 Taxonomy of MSME sustainability standards
3.1 Mandatory standards
3.1.1 Local pollution mandatory standards
There are seven Acts relating to environment protection administered by Ministry of
Environment, Forest and Climate Change (MoEF &CC) namely Indian Forest Act, 1927,
Wildlife (Protection) Act, 1972, Forest (Conservation Act, 1980, AIR (Prevention and
Control) Act, 1981, Water (Prevention and Control of Pollution) Act, 1974, Environment
(Protection) Act, 1986 and Water (Prevention and Control of Pollution) Cess Act, 1977.
Most of compliance monitoring and enforcement is done by SPCBs. Under the Water Act,
the Air Act and the Environment (Protection) Act, the pollution control boards have the
authority to issue and revoke consents to operate, require self-monitoring and reporting,
conduct sampling, inspect facilities, require corrective action and prescribe compliance
schedules. The enforcement powers include emergency measures of disconnecting water or
power supply and facility closure, which are widely used in some states. According to the
Hazardous Wastes (Management and Handling) Rules of 1989, SPCBs can, with CPCB
approval, impose administrative fines for any violation of those rules (OECD, 2006).
Despite the legislative ‘teeth’ given to the SPCBs enforcement powers, the story remains
discouraging on the ground. Assessments for SPCB’s effectiveness show that these
organizations remain understaffed which result in a low ratio of technical staff to number
of industries to be regulated. Most staff members are overstretched with responsibilities
which make the quality of monitoring poor (Planning Commission, 2012). An additional
problematic factor is that many of the above standards for pollution are concentration
based29 and not industry based.
To ease the monitoring process, MoEF & CC has categorized industries as “Red”, “Orange”,
“Green” and “White”30 with the purpose of facilitating decisions related to location of these
industries and surveillance/inspection of pollution levels from these industries. The criteria
29 Concentration based standards do not put a cap on a particular industries which often leads to pollution
loads exceeding the carrying capacities of the environmental resource i.e. air or water.
30 The categorization is as follows: Industrial Sectors having Pollution Index score of 60 and above – Red
category, Industrial Sectors having Pollution Index score of 41 to 59 –Orange category, Industrial Sectors
having Pollution Index score of 21 to 40 –Green category, Industrial Sectors having Pollution Index score
incl. & up to 20 – White category
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 49
of categorization of industrial sectors are based on the Pollution Index which is a function
of the emissions (air pollutants), effluents (water pollutants), hazardous wastes generated
and consumption of resources.
Eleven sectoral clusters of MSMEs have been identified by FMC, IICA and GIZ (2013) to
have the most harmful impact on the environment. These include the sectors, namely-
foundry, sponge iron, leather tanning, textiles, dyes and chemicals, electroplating, brick
kilns, ceramics, glass and glassware, small cement plants and pulp & paper. Table 3 below
presents both the pollution aspect of these industries as well as their contribution to the
economy. It is unfortunate that despite their social and economic significance, around 70
per cent of the total industrial pollution is contributed by SMEs in India (FMC, IICA, &
GIZ, 2013). In most respects, these sectors present the typical tradeoffs between natural and
physical capital discussed in environment economics literature.
There is thus great scope for these industries to move towards sustainability pathways. FMC,
IICA and GIZ (2013) note that the pollution per unit of production is generally higher in SMEs
than that of the corresponding large units, partly due to the use of obsolete technologies and
poor management practices, and partly because most of these units do not come under the
ambit of regulatory authorities. This needs to be improved upon. Also, it is observed that large
industries comply with environmental regulations as they have the financial capacity to install
pollution control technologies, while smaller companies tend to struggle more to achieve
conformance with the law.
Also, in India, Industries falling under 17 categories of (large & medium scale) highly
polluting industries have to necessarily install continuous effluent/emission monitoring
systems (CETPs). In many cases, industries have been asked to relocate or shutdown if they
are unable to install such systems. The latest Annual report of the MoEF & CC shows that as
on May 31, 2016, 1733 industries had installed CETPs and closure directions have been given
to 1000 plus industries for not complying with these norms.
For all businesses and from the upstream and downstream value chain perspective, it is ne-
cessary to take into account the environmental impacts so that creation of products and delivery
of services by an organization can be done in an environmentally and socially benign manner.
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50 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Table 3: Environmental impact of MSME sectors and their economic contribution
Sector Sub sector Environmental
issues
Industry
category
Total
production
Employment Total
clusters
Engineering Foundry Air emissions RED 8.18 MTPA 0.65 mn 28
Sponge iron Solid waste RED 21.2 MTPA 0.52 mn 29
Wastewater
Leather and
footwear
Leather
tanning
Water pollution RED 0.27 MTPA
2.5 mn 17
Hazardous solid
waste
Textile and
garments
Textile and
garments
dyeing and
processing
Water pollution RED 54.96 bn sq.
metres of
cloth
35 mn 113
Hazardous solid
waste
Chemical Dyes and
chemicals
Water pollution RED 28.7 MT NA 12
Electroplating Hazardous
waste
RED 28000
tonnes
50000 20
Non-
metallic
industries
Brick kilns Air pollution NA 140 bn
bricks
10 mn 40
Ceramic tiles
and
sanitaryware
Air pollution RED 340 mn sq.
metres-
ceramic
tiles
0.55 mn 16
Solid waste
Glassware Air pollution RED 0.8 mn 4
Solid waste
Mini cement
plants
Air pollution RED 176 mn MT 0.14 mn 10
Paper and
paper
products
Paper industry Air pollution RED 10.5 mn
tonnes
0.46 mn 4
Water pollution
Biodiversity
Source: FMC, IICA, & GIZ (2013)
The other important local pollution mandatory standard is actually a product standard rather
than an industry standard. Bharat stage emission standards (BSES) are air pollution
emission standards for motor vehicles. These standards are set by the Central Pollution
Control Board under the Ministry of Environment & Forests and climate change. It is
mandated that all new vehicles have to be compliant with these regulations.
https://en.wikipedia.org/wiki/Motor_vehicle_emissions
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 51
3.1.2 Other mandatory quality standards
Other than the pollution standards there are a series of product quality standards that are
important from the Indian standpoint. TheBureau of Indian Standards (BIS) enforces
mandatory certifications for a various products in the interest of public health and safety,
security, infrastructure requirements, etc. Currently there are 140 products under the
mandatory certification list which include products such as household electrical goods, food
products, automobile accessories, stoves and valves, medical equipment, etc.
3.2 Voluntary standards
3.2.1 Local pollution voluntary standards
A voluntary environmental management system benchmark that has gained some degree of
prominence in India is the International Organization for Standardization (ISO), which is a
non-governmental organization whose members are the national standard setting bodies in
countries around the world. Its standards are widely recognized and endorsed by international
bodies (e.g. the WTO) and national governments. Within this, the ISO-14001 series of
standards specify the standard for establishment and maintenance of an environmental
management system (EMS).
Data from the ISO site shows that there were around 4362 companies in India that were
ISO-14001 certified. While the increasing trend of certification among Indian firms is
heartening, the amount is still quite small in absolute terms. Among MSMEs, Padma et al.
(2008) find that export-oriented firms focus more on identifying and managing
environmental issues and processes to improve their end products. In view of the greater
international integration of production processes, as envisaged under GVC, the number of
certified business are all set to increase.
3.2.2 Energy efficiency voluntary standards
As a part of its Intended Nationally Determined Contribution (INDC), India has declared
that it would reduce the emissions intensity of its GDP by 33 to 35 percent by 2030 from
2005 level. The current policy agenda is thus highly focused on achieving greater energy
efficiency in different consuming sectors.
As part of this, the Perform and Trade (PAT) Scheme empowers the Indian government to
identify energy-intensive industries as designated consumers (DC) and set mandatory energy
conservation standards for them. Under this Act, the Ministry of Power’s Bureau of Energy
Table 4: Number of ISO-14001 certified businesses in India
Country 2010 2011 2012 2013 2014 2015
India ISO
Certificates
3878 4147 4286 5872 6443 6782
India ISO Sites 2252 2516 4886 2752 4213 4362
Source: ISO (2017)
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52 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Efficiency (BEE) identified DCs from 15 sectors, including the 8 sectors targeted in the PAT
scheme. Each facility under the PAT Scheme has been assigned a specific energy
consumption (SEC) reduction target, compared to its baseline SEC31, to be achieved by March
2015. DCs receive tradable, certified energy savings credits if they achieve efficiency gains
beyond their targets. If they fall short of their targets they can buy energy savings credits to
make up the difference.
In its initial two rounds, the focus has been on larger industrial units consuming energy
beyond a set level. The sectors covered under PAT-I are aluminum, cement, chlor-alkali,
fertilizer, iron & steel, paper & pulp, textile and thermal power stations. There has been a
deepening and widening of PAT in its second round to include more DCs in identified
sectors and more sectors such refinery, railways and electricity Discoms.
Efforts are currently underway that seek to include MSME’s under this policy’s umbrella
as well. As a part of their research, Sekhar, Dhingra and Pal (2015) compare SECs in select
MSME clusters and identify the best performers under different product groups. Table 5
below presents the SEC comparisons in different MSME clusters. These numbers can be
used at a later date as the efficiency benchmarks for the MSME sector.
31 SEC is the energy consumed per unit of production and is generally expressed in terms of toe per ton of
production.
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 53
Table 5: SEC comparison in MSME clusters
Sub sector Cluster Product/Process SEC (toe/tonne)
Min. Average Max.
Brass Bhubaneshwar Utensils 0.46 1.36 2.08
Jagadhri Brass 0.29 0.73 0.96
Aluminium 0.25 1.19 2.75
Jamnagar Extrusion 0.08 0.10 0.19
Foundry 0.06 0.08 0.11
Electroplating 0.03 0.08 0.14
Machining 0.01 0.04 0.19
Brick Varanasi Fired clay bricks 0.024 0.028 0.033
Ceramics &
refractories
Morbi Wall tiles 0.07 0.23 0.68
Floor tiles 0.12 0.20 0.28
Vitrified tiles 0.08 0.19 0.59
Sanitary ware 0.005 0.10 0.35
Spray dryer powder 0.04 0.05 0.06
East & West Godavari Refractory bricks 0.10 0.74 1.76
Ceramic jars 0.67 0.90 1.19
Khurja Ceramic and potteries 0.17 0.20 0.47
Thangarh Tiles, sanitary ware 0.08 0.09 0.10
Chemical Ahmedabad Chemicals 0.01 0.52 1.06
Dyes 0.03 0.69 1.54
Vapi Chemicals 0.01 0.55 2.76
Dyes and pigments 0.02 0.44 1.98
Dairy Gujarat Milk chilling &pasteurization 0.002 0.003 0.007
Other milk products 0.009 0.097 0.21
Foundry Batala, Jalandhar & Ludhiana Foundry 0.127 0.147 0.167
Belgaum Cupola 0.045 0.069 0.093
Induction furnace 0.048 0.058 0.067
Coimbatore Cupola 0.043 0.075 0.11
Induction furnace 0.048 0.058 0.067
Galvanizing and
wire-drawing
Howrah Galvanizing 0.03 0.10 0.17
Wire drawing 0.01 0.04 0.07
Ice making Bhimavaram Ice blocks 0.001 0.008 0.013
Paper Muzaffarnagar Kraft paper 0.06 0.45 1.05
Rice mill Ganjam Rice 0.26 0.37 0.48
Vellore Rice 0.036 0.088 0.143
Warangal Raw rice 0.001 0.003 0.004
Parboiled rice 0.053 0.063 0.086
Sponge iron Orissa Sponge iron 0.64 0.70 0.82
Tea Jorhat Coal based 0.58 0.70 0.82
Natural gas based 0.40 0.50 0.60
Textiles Solapur Towels and blankets 0.07 0.34 1.58
Surat Sarees and dress materials 0.14 0.40 1.26
Tirupur Compacting 0.02 0.07 0.31
Dyeing and bleaching 0.49 1.02 2.06
Washing, heat setting and drying 0.23 0.63 0.92
Knitting 0.01 0.02 0.04
Glass Firozabad Glass products 0.30 0.34 0.38
Note: Analysis primarily based on data collected under the BEE-SME program (2007-12)
Source: Sekhar, Dhingra & Pal (2015)
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54 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
3.2.3 Other voluntary quality standards
Another key quality standard operational in India is the ISI mark instituted by BIS which
certifies that the product conforms to BIS standards. BIS has put in place over 15800
standards in diverse fields such as agriculture, chemicals, engineering, medical instruments,
textiles, etc.
Among sectors, the agriculture and food products sector has the most number of standards
instituted. In fact the ‘Report of the Inter-Ministerial Committee for Boosting Exports from
MSME Sector 2013’ (MoF, 2013) highlights that quality certification is a key concern for
the food processing sector and needs to be expeditiously looked into. There are a series of
Indian standards such as Agmark, FPO mark and India Organic certificate mark used in this
sector. There are a number of international certifications that are gaining ground as well.
These include GlobalGAP and its local variant IndiaGAP32, chain of custody certification
(COC), Fairtrade, etc. These are however in their nascent stages as there is a lack of
awareness among producers and an inability of smaller producers to access certification
mechanisms due to financial constraints.
3.3 Designing a comprehensive voluntary EMS assessment tool
The Government of India has recently announced the ZED Assessment Mechanism that
envisages promotion of Zero Defect and Zero Effect (ZED) manufacturing amongst
MSMEs and ZED Assessmentfor their certification. The mechanism aims to improve the
quality and competitiveness of Indian MSME over a period of time. It will also provide a
benchmark for units to strive to continuously improve its processes thereby aiming to move
up the ZED maturity assessment model. This would also ensure that the larger companies
investing in India have a ready-made vendor base to support their activities and an expansive
base of trained human capital who can contribute to their manufacturing process without
much retraining (MSME, 2016b). The GoI document lists multiple benefits that would
accrue to business going for this assessment such as reduction in wastages, increased
productivity, expansion of market as Indian Offset Partners (IOPs), become vendors to
PSUs, have more IPRs, develop new products and processes etc.
Under the ZED certification, enterprises would be assessed under 35 different criteria. Some
of the key categories of environment assessment under ZED are as follows:
Process Design for Environmental Management
o Technology selection and continual upgradation
o Systems for abatement of effluent, emissions and wastes
o Systems for energy efficiency
o Systems for natural resource conservation
32 Following GlobalGAP, Good Agricultural Practices Basic Requirements, has been developed for India
by a committee constituted by Quality Council of India at the request of Food Safety Standards Authority
of India, Ministry of Health, Govt of India for implementation by small and medium farmers, who
dominate the Indian agricultural landscape. It is interesting that due to barriers in India, parallel initiatives
by the public and private sectors have led to two co-existing and overlapping local GAP standards.
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 55
Preproduction (startup activities) for environmental Management
o Installation of environmental protection and measuring equipment
Production and maintenance activities
o Planned maintenance of Environmental management systems
o Planned maintenance of energy control systems
Outcomes for Environmental Performance
o Optimal use of natural resources
o Energy performance
o Environmental performance – air/effluent / solid waste
4 Social welfare agenda
It has been argued that India ‘probably has the most comprehensive legal structure for labour
welfare and protection in the world’ (Deshingkar, 2009). Table 6 below lists some of the
key Acts that govern labour welfare in Indian industries.
Despite the existence of these laws, there is a large part of industrial labour that operates
outside of this welfare net. Most labour market laws are applicable to formal sector firms,
as establishments employing below a certain number of workers are exempt from them.
This effectively translates into the fact that about 93 percent of India’s workers who are in
informal employment, do not form part of this and thus do not enjoy the protection of
minimum conditions of work (NCEUS, 2009). The NCEUS report has also calculated that
“85 percent of all casual workers in rural areas and 57 percent of them in urban areas get
wages below the minimum wages”. This situation requires drastic improvement.
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56 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Table 6: Key acts governing labour welfare in India
Name of Act Objectives & applicability Compliance requirements
Factories Act, 1948 The Act provides for the health,
safety, welfare, service conditions
and other aspects of workers in
factories. It covers all workers
employed in factory premises
directly or through an agency.
Licensing and renewal of license
Provision of safety measures
Provision of welfare measures
Payment of wages and overtime wages
Maintenance of registers
Submission of returns
Industrial Disputes
Act, 1947
This Act provides for machinery
and procedure for the investigation
and settlement of industrial disputes
for industrial establishments
carrying on business, trade,
manufacture, etc.
Prevention of unfair labour practices
Prior permission from regulatory
bodies for retrenchment and closure
Payment of wages on account of
retrenchment or closure
Industrial
Employment and
Standing Orders Act,
1946
This Act requires employers to
define and publish standing orders
and to make them known to
workmen employed by them
Formulation of service rules and
obtaining of approvals
Display of standing orders in a
prominent place
Minimum Wages Act,
1948
This Act provides for fixing
minimum rates of wages in certain
employments
Provision of minimum rates of wages
Maintenance of registers
Submission of returns
Payment of Wages
Act, 1965
The Act provides for payment of
bonus to persons employed in
certain establishments
Payment of bonus
Submission of returns
Contract Labour
(Regulation &
Abolition) Act, 1970
and Rules
The Act regulates the employment
of contract labour in certain
establishments and provides for its
abolition in certain circumstances.
Working conditions of workmen
Adequate facilities like drinking
water, safety, etc.
Maintenance of registers
Submission of returns
Employee State
Insurance Act, 1948
The Act provides for provision of
benefits to employees in case of
sickness, maternity, employment
injury, etc.
Remittance of monthly contribution
Maintenance of registers
Submission of returns
Employee's Provident
Fund and
Miscellaneous
Provisions Act, 1952
This Act provides for compulsory
institution of contributory provident
funds, pension funds and deposit
linked insurance funds for
employees
Payment of monthly contribution
Maintenance of registers
Submission of returns
5 Barriers and incentives for MSME sustainability standards
As per the existing regulatory frame-work, there is more of a rigid mandate of “Comply or
Close Down” rather than “Comply and Benefit” as far as sustainability standards are
concerned. Details of the command-and-control approaches have already been furnished
earlier. However, in literature there are multiple papers that have looked at Indian MSMEs
and the benefits that accrue from better environmental management systems.
For example, most ISO 14001 certified companies in India confirm that “reduction in waste”
and cost savings, are the largest benefit they receive from sustainability standards
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 57
implementation (Khanna, 2008). Other important benefits accruing to MSMEs, noted in
literature are organizational and competitiveness benefits and increased market access
(Padma et al., 2008; Prakash,2000; Sawhney, 2004). Their findings also suggested that
export-oriented firms focus more on identifying and managing environmental issues and
processes to improve their end products.
From the view of barriers, Dasgupta (1996) highlights two socio-economic reasons
characterizing the lack of environmental compliance. Firstly, most SMEs have a low capital
output ratio compared to larger units (Sandesara, 1991). The investment surplus is limited,
constraining the standard business argument of improved technologies leading to better
business in the long run. This argument would be valid for both, end-of-the-pipe solutions
as well as overhauls made in nested production processes. It is from this view point that the
Indian government offers various subsidy and fee reimbursement schemesfor CETP setup,
ISO certification as well as ZED certification.
Secondly, with heavy emphasis on daily production, limited awareness of environmental
technologies and better processes, the environmental decision making is severely constrained
(Sethuraman & Ahmed, 1992). Natu (1999) observing the sufferings of the small scale
industries in India due to small scale manufacture, meager profitability, severe competition,
limited organisation and importance of process secrecy, suggested that it will be difficult for
SMEs to adopt and maintain ISO 14001 (Singh et.al., 2015).
FMC (2016) in their assessment however make an important point. There is a widespread
notion that only substantive higher technology equipment changes can lead to energy
savings. However, even with large-scale manpower skilling, there substantial savings in
energy efficiency can be achieved in usual day-to-day operations. Thus, to supplement all
government policies and schemes that focus on tangible schemes which can lead to capital
infusion by linking up with formal financial institutions, focus needs to be also on greater
awareness creation and skill training. The move towards sustainability standards needs to
be an amalgamation of availability of finance, raw material sources, and knowledge of both,
the proprietor and owner. This becomes a significant component for the SMEs to implement
environmental management practices.
Involvement and commitment of founder/owner and top management into environmental
management practices are key to successful adoption of sustainability standards by Indian
SMEs, as demonstrated by Sethuraman and Ahmed (1992) and Dasgupta (2000.) Some of
the other motivations for meeting sustainability standards discussed in literature are for
better regulatory compliance, prevention of environmental incidents and to portray the
image of an environmentally responsive firm.
6 Demand for finance and SMEs
However, one of the major deterrents in the progress of MSMEs is the access to finance.
Lack of adequate and timely access to finance limits the potential of the sector in its
contribution to the economy. The MSME sector requires funding of mainly two types, either
for long term fund investment in fixed assets, for setting up or expansion of units or for
working capital needs, to meet the operational requirement of business. The long-term credit
is mostly provided by financial institutions like Commercial Banks, State financial
Corporations (SFCs), Non-Banking Financial Companies (NBFCs, SIDBI etc. The working
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58 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
capital needs are met by the banking sector, including Scheduled Commercial Banks
(SCBs), Regional Rural Banks (RRBs) etc. However, it has been estimated that around 92%
of all MSMEs are outside the coverage of formal financial channels, and thus compelled to
raise money through informal channels, which exploits them by charging higher interest
rates and thus causing a slow-down in progress of the MSME sector.
Majority of the MSME sector demand comprises of finance in the form of debt while equity
as a source of finance has been under-utilized. Equity is not a popular option due to the lack
of awareness about MSMEs and the legal structure of the firms. Most of the MSMEs are
proprietorship, which limits their ability to raise finance through equity. According to the
4th census report (2006-07) of MSME sector, 87.23% share of enterprises had access to self-
finance/no finance. The share of enterprises with access to finance from institutional and
non-institutional sources stood at 10.87% and 1.05% respectively, demonstrating a gap in
credit availability to the sector. The 2012 IFC Report on Micro, Small and Medium
Enterprise Finance in India further corroborated the existing finance gap, as it stated that an
overall finance gap of INR 20.9 trillion was present in the MSME sector. The report also
stated a break-up of this gap into a debt gap standing at INR 19 trillion and an equity gap at
INR 1.9 trillion, which elucidates that debt financing is a preferred mode of option by the
MSMEs. The final seal on the existence of a finance gap is provided by Planning Commission
statistics. In a paper on the flow of private sector investments for MSME sector, the amount
outstanding to the MSE enterprises by Scheduled Commercial Banks (SCBs) was found to be
increasing from year to year. For instance, amount outstanding in March 2009 recorded a
year-on-year growth of 19.94% while the same figure had increased to 34.13% by March
2011. These figures from various reports collectively prove the point that a finance gap exists
in the MSME sector, which needs to be addressed to ensure full development.
The problem of inadequate finance faced by the MSME sector can be analysed from a
“three-fold perspective” (Agasty, 2016). Firstly, the demand side. Most of the MSMEs are
small businesses that have very low financial awareness. They are not fully aware of the
relevant financial avenues and public support schemes available to their sector, and thus
find it difficult to expand their business. In some cases, they lack the technical know-how
and the necessary wherewithal to provide the required information to avail these schemes.
Most of the micro enterprise owners have low levels of education or are first generation
entrepreneurs, having limited training in resource planning, thereby making it more difficult
for them to access debt financing.
Secondly, the supply side. Banks and financial institutions face challenges in credit risk
assessment of MSMEs due to the absence of financial information. Many MSME
entrepreneurs prefer to transact in cash as they have limited incentives to maintain financial
history. A lack of credit track record makes it difficult for financial institutions to assess the
credit worthiness, thereby resulting in adverse selection, i.e. either higher interest rates being
charged or no loan being sanctioned at all. Outreach to MSMEs, engaging them as customers,
building up transaction and credit history, are all challenged by the lack of a formal legal
structure. Another factor is the limited access to immovable collaterals of MSMEs,
particularly in knowledge based industries. The security needed to finance the amount of loan
required is often in scarcity, adding yet another obstacle in their access to adequate debt from
formal financial institutions.
Thirdly, the intermediary channels. It has been noticed that the bankers that provide the loans
to MSMEs, serving as intermediaries, are not exposed to the MSME sector and the constraints
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 59
faced by it. This limits their capacity to provide correct financing solutions, adding to the woes
of the MSME sector.
Fortunately, Government of India has been playing an active role in supporting the MSME
sector. Various acts have been formulated and existing acts revised to facilitate the MSMEs
in accessing adequate finance. Several schemes such as the Credit Guarantee Scheme (CGS)
of Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) have been
implemented and proven to be successful.
Banks are pushed to lend to MSMEs as per the Priority Sector Lending requirements drafted
by RBI. As per the recommendations of the Prime Minister’s Task Force on MSMEs in
2010, banks were advised to achieve a 20% year-on-year growth in credit to micro and small
enterprises and a 10% annual growth in the number of micro enterprise accounts. The recent
RBI guidelines also advise banks that 60% of MSE advances should go to micro enterprises.
The government has also launched the MUDRABank with a corpus of Rs. 20,000 crore and
a credit guarantee fund of Rs. 3,000 crore to fund small and micro units. The Bank has been
set up as a subsidiary unit of Small Industries Development Bank of India (SIDBI) and has
already succeeded in reaching out to a large number of micro enterprises. (Agasty, 2016).
Figure 1: Current sources of finance for the SME sector
Source: IFC (2012)
Current
Sources of
Finance
Formal
Sources
Banking
Institutions
Scheduled
Commercial Banks
(SCBs)
Public Banks
Private Banks
Foreign Banks
Small
Banks
Regional
Rural Banks
(RRBs)
Urban
Cooperative
Banks (UCBs)
Government
Financing Agencies
State Financial
Corporations
(SFCs)
State Industrial
Development
Corporation
Self-Equity
Informal Sources
Instituional
Registered
Chit Funds
Unregistered
Chit Funds
Registered
Moneylenders
Non-Institutional
Own
Savings
Family
Business
Family/
Friends
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 61
Small Industries Development Bank of India (SIDBI) is the principal financial institution to
promote, finance and develop the MSME sector and it also serves as a coordinator of other
institutions engaged in similar activities and thus deserves a special mention. It provides
financial support to MSMEs through various ways. These include refinancing Primary
Lending Institutions (PLIs) for further lending to MSMEs, providing financial assistance in
the form of grants, loans etc. to MFIs/NGOs for on-lending to micro enterprises and making
them able to take up income generating activities by aiding through their wide network of
branches. Further, SIDBI works to bridge the financial and non-financial gaps in the MSME
sector. One of the strategies adopted to address the financial gap is facilitating risk capital
assistance to start-ups and early stage ventures. Other methods include the implementation
of the Srijan Scheme that aims to support MSMEs towards development and up-scaling.
The non-financial gaps are dealt with by setting up loan facilitation to MSMEs that helps
them to access credit directly and indirectly from banks. SIDBI has also set up Credit
Advisory Centres (CACs), which provide free consultation by SIDBI officials and retired
bankers to the MSMEs about getting credit from banks and financial institutions. SIDBI
also addressed the information gap faced by MSMEs by launching a website
(www.smallB.in) which serves as a virtual mentor. SIDBI also facilitates the supply side
constraints in MSMEs access to finance by helping banks in quicker credit sanction. This
has been achieved through the setting up of SME Rating Agency of India Ltd. (SMERA) in
September 2005. It is a third-party rating agency particularly for MSME which provides a
comprehensive, transparent and reliable ratings and risk profiling. By the end of September
2012, SMERA had assigned credit rating to about 65% micro enterprises. SIDBI has been
supporting the MSME sector to its full capacity and thus plays a pivotal role in developing
the MSME sector (Rao & Noorinasab, 2013).
Moreover, under the Pradhan Mantri Mudra Yojana (April 2015), about 1.5 crore new
entrepreneurs received financial support from various banks and microfinance institutions
to set up small businesses. Several funds, like the India Aspiration Fund and the SIDBI
Make in India for Small Enterprises are further additions to the financial options made
available to the MSME sector by the Government.
Sustainable business conduct is now a pre-requisite in every field. Responsible production
encouraged by standards, such as the ‘Corporate Social Responsibility’ standards encourage
financial inclusion. This helps to create a sustainable financial system that offers a decent
range of financial services, which in turn helps small business to improve the state of their
access to finance. Further, sustainable standards include the industry specific standards
which cater to the specific needs and capabilities of that sector. They encourage capacity
building, as enterprises incorporate sustainability into their operations and work together
with other members of the value chain or industry to address shared challenges more
effectively and efficiently (UNCTAD, 2011c).
It is assumed that MSMEs can produce sustainably only through adoption of the most
advanced technology which requires huge investment. Access to finance is an important
need but sustainability can also be achieved through smart alignments, retrofitting, and
upgradation of skills of labour and with other small initiatives. Adoption of sustainability
standards encourages these practices and provides a base to build on, which in turn not only
increases their chances to access finance, but also helps them in maintaining and widening
that access (Sanwal, 2016).
Rajat Kathuria / Amrita Goldar / Sajal Jain
62 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
7 Conclusions
Based on global experiences and various studies in India, it has been seen that the problems
faced by the MSMEs can be analyzed from both the demand and supply sides (FMC, 2016).
On the demand side, most of the MSMEs have very low awareness of relevant financial
products and public support schemes. This leads to them not partaking in many of the
supportive programmes that the Government of India has initiated to provide greater access
to credit and technology up-gradation. Whereas, on the supply side the main bottlenecks
include lack of innovative financial products and public schemes that enable cluster
enterprises to switch to green technology and adopt broader sustainability standards that
help MSMEs bring down their operating costs. Besides, local bankers, credit officers and
other actors in the credit delivery channels are often not trained to be sensitive towards the
needs of MSMEs for wider sustainability issues (FMC, 2016). Both of these factors have
limited the MSME owners’ ability to address sustainable production.
Based on our assessment, we believe that a three pronged strategy is what would work best
in such a scenario:
1. There are a significant number of enterprises that are going for voluntary EMS
certifications to improve their market access. This needs to be further encouraged. The
production networks created under Global Value Chains should be tapped into more
effectively, so that better technologies and environmental management practices are
necessitated for firms seeking to integrate into these. This would help solve the lack of
demand for environmental management systems and about awareness of sustainability
standards among MSMEs.
2. For MSMEs seeking finance, environmental standards and benchmarks could be
included as part of their rating mechanism. For example, the SME rating Agency of
India or SMERA assesses firms on the basis of their business and financial risk as well
as their management experience. Environmental criteria, such as the ones suggested by
ZED, could easily be incorporated as part of the rating methodology.
3. Even from the government procurement and eligibility of specific firms for claiming
promotional policies angle, greater preference needs to be given to firms that comply
with sustainability standards. Firms’ adherence to labour standards can easily be gauged
from official records, etc; gauging environmental performance is trickier. We would
suggest that more firms be encouraged to go for different types of environmental
certifications such as ISO-14001 and ZED to provide records of compliance. Firms
going for greater energy efficiency investments also need to be promoted.
Drivers and constraints for adopting sustainability standardsin SMEs: an Indian case study (Part I: Macro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 63
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Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part II: Micro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 65
IV Drivers and constraints for adopting sustainability standards in
small and medium-sized enterprises (SMEs) and the demand for
finance: an Indian case study (Part II: Micro perspective)
Shikhar Jain & Archith Ashok, CII-ITC Centre of Excellence for Sustainable
Development
1 Introduction
Indian Micro, Small and Medium Enterprises (MSMEs) contribute about 45% of country’s
manufacturing output, generate employment for over 40% of the Indian working class, and,
demonstrate one of the fastest, 11.5%,33 annual growth rates for any other size of industry
in the world. MSMEs contribute 38% of total GDP. Manufacturing sector MSMEs
contribute around 7.04% of total GDP (2012-13 figures). 42.38% of the total export earnings
of India came from MSME sector. However, the contribution of the MSME in
manufacturing sector to India’s GDP recorded at 8 per cent for 2011-1234, has been
comparatively low comparing to some of the other global economies. Manufacturing sector
contribution to the GDP has the capacity to reach 15% by the year 202035. Textile sector
contributes 4% of total GDP and 13.5% of total exports from India, an output largely
accredited to the MSMEs operating in the textile sector.
Global Value Chains provide an opportunity for small and medium enterprises to
upscale their business models and to grow across borders36. However, MSMEs face a
number of challenges in meeting product quality and sustainability standards demanded by
global value chains, often restricting their full potential in integrating with potential foreign
business opportunities.
In some sectors sustainability standards have become so crucially important for the
customers that producers need to either adhere to those standards or their products and
services may get shelved in the future. While there are some MSMEs who are delaying
adoption of standards in their businesses due to sheer ignorance, there are a large number
of MSMEs who genuinely lack resources, time and know-how necessary for integrating
with the standards requirements.
The willingness and capability of MSMEs to adopt sustainable practices and seize better
business opportunities generally face size-related resource constraints, skill deficits and
knowledge limitations. On account of inborn disadvantages of being small, MSMEs find it
difficult to get necessary finance, buy the latest machinery, train personnel etc.,adhering to
environmental, social, labor and technological peculiarities that come with standards add
33 Sustainable trends of MSME in India: An empirical study. Dr. M. Meganathan, P. Balaji Kumar, R.
Sarvanan, Feb 2015 issue of IJRM.
34 MSME Annual Report 2013-14, (https://assets.kpmg.com/content/dam/kpmg/pdf/2016/03/The-new-
wave-Indian-MSME.pdf)
35 http://www.business-standard.com/article/sme/msme-share-of-gdp-can-be-raised-to-15-pc-by-2020-
study-114102701382_1.html
36 http://techstory.in/make-in-india-challenges/
Shikhar Jain / Archith Ashok
66 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
extra burden on the MSMEs. Many of the standards may require dismantling their existing
infrastructure, practices and methods and adopting completely new ones.
Small enterprises work under several limitations. Their constraints range from financial to
technological, location to labor, technical to resources. Cultural, traditional, attitudinal and
leadership related issues pose different kinds of barriers. Emergence of VSS in global
exports has created opportunities for some, but it looks like a lonely walk for many others.
Globalization has increased competition and accelerated the need for better standards. In
order to meet the sustainability standards, small businesses need to change their traditional
ways of production. Mostly operated by non-state parties and civil society groups,
sustainability standards are not mandated by the Law. Producers are voluntary motivated to
adopt these standards as they are driven by buyer demands and consumer preferences and
hence promise better market access.
Governments, along with international organizations, investors and suppliers, are important
stakeholders for MSME integration in global value chains. India is moving from a highly
‘protected’ centralized economy to open global economy led by the private sector. Though
government is highly supportive and sensitive to the limitations faced by the MSME sector
in India, it is a leading supporter of the sustainable development goals too. The recent
governments at the center in India have taken several measures to ease MSME operations.
The policy framework in India is undergoing remarkable changes in the last few years,
incorporating considerations for environmental and social sustainability in development of
MSMEs; hence, directly or indirectly facilitating the dissemination of Voluntary
Sustainability Standards.
Sustainability concerns have started taking roots in Indian domestic market also, albeit at a
very miniscule level. Indian middle classes are increasingly becoming concerned about the
environmental impacts, labor issues, product safety, water-usage, recycling, etc., involving
all types of products. Concerned citizen groups are gaining ground among the Indian middle
classes. The emergence of sustainability concerns in India has created space for organic and
natural products; mainly in food and agriculture, textiles & clothing, beauty & cosmetics
sectors. MSMEs are closer to the resource bases and their impacts are easily identifiable.
Hence ignoring sustainability concerns will not be possible for them for long. If they have
to maintain their profitability and growth, integrating sustainability in their businesses will
be a winning opportunity for them.
This study aims to assess and identify some of the factors which encourage or discourage
the MSMEs, in making decisions for adopting the voluntary standards demanded by their
buyers, consumers and retailers.
This paper will assess the impacts of voluntary sustainability standards on the firms and
other parameters; environmental, social, economic, etc. A few case studies will be
undertaken on the struggles and turnarounds for sustainability, reflections of important
stakeholders will be part of the report.
A separate section on VSS and demand for finance by MSMEs will be devoted to understand
the role of donors and financial institutions in promoting VSS. We shall take a keen look on
how MSMEs are figuring in international donor interests. And, what challenges are
prevailing in sustainability funding and finances for MSMEs.
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part II: Micro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 67
Finally we will try to come out with some meaningful recommendations for promoting an
understanding around MSME’s interaction with voluntary sustainability standards.
2 Review of literature
The available literature demonstrates relevance and opportunities for Micro, Small and
Medium Enterprises in India vis-à-vis Voluntary Sustainability Standards, their challenges
in adopting the VSS and limited resources and financial support available to them. To
understand the trends and justify context of the present study, following literature has been
studied.
Sustainable Trends of MSME in India; An Emprical Study by Dr. M. Meganathan, P.
Balaji Kumar & R. Saravanan (Feb 2015). This Study attempted to identify obstacles faced
by MSMEs while evaluating working enterprises, investments and average production of
MSMEs. Some of the major challenges identified by this study throw light on lack of
financial assistance MSMEs face in adopting new product-line or new processes, leadership
crises faced by MSMEs and lack of necessary know-how in accessing favorable
technologies and remain competitive.
Voluntary Sustainability Standards and Value Chain Governance by Kathleen
Sexsmith & Jason Potts for IISD (July 2009). This study throws light on how sustainability
standards affect the distribution of decision‐ making power in global value chains.
The Curious Case of Environmental Standards and Its Trade Impact: An integrated
Indian and Norwegian Perspective a CUTS CITEE study by Archana Jatkar gives a
different perspective on the dichotomy of EcoLabels and environmental sustainability in
textile market. It studies how EcoLabels on the one hand penetrated the consumer mindsets
worldwide, and on the other posing challenges to producers in European and North
American Markets.
Voluntary Sustainability Standards: An Overview by Alex Marx, Arjun Sharma, Emile
Becault, gives an in-depth idea about emergence of VSS, how they are operated and what
impacts VSS have on business, society and environment.
3 Methodology
We conducted interviews with MSMEs & their stakeholders, noted down their understanding
and concerns regarding VSS. We interacted with standards organizations, analyzed
documents, case studies and views available on their websites. We reviewed the existing
literature on the MSMEs and their interaction with voluntary standards. We studied the
different perspectives on MSME financing and role of donors. We went through international
and domestic case studies of successes in sustainable transformations made by MSMEs and
their challenges.
Standards organizations, like Better Cotton Initiatives, provided valuable insights on how
voluntary standards are differentiated with mandatory requirements, how the organic,
Shikhar Jain / Archith Ashok
68 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
environmental and labor requirements separate from voluntary sustainability commitments of
the firms. They helped us understand why working with the primary producers, farmers, and
small enterprises is important but ignored part of sustainability. They also pointed out to the
advantages larger organizations have in adopting sustainability standards. Based on the
discussions with the standards organizations, efforts were made to identify some key MSMEs
who could identify the link between sustainability initiatives and better business outcomes.
We also spoke to some senior Consultantsworking closely with the industry, helping
MSMEs in their pursuit for transformation. Rajesh Bheda Consultants (RBC) is one such
group of committed people. They gave us a valuable insight into how important it is for the
industry to internalize sustainability in their core business strategy and not always wait for
external resources. They pointed out the importance of innovativeness for MSMEs that is
being ignored. They gave a number of examples how MSMEs have overcome their energy,
water and chemical compliance problems adopting to innovative and simple ideas.
We also received answers to our questionnaires from a few MSMEs who have successfully
integrated sustainability standards in their businesses. Sree Kapagambal Mills Ltd. is one of
the respondents. Their response gave us information about how VSS can help company gain
recognition and respect in a crowded market place by following sustainable and responsible
practices.
List of main stakeholders who were spoken to for the study:
SN Type of Stakeholder Stakeholder Size
1 Sectors SMEs operating within priority sectors 5
2 SME Functionaries SME chiefs and compliance officers 5
3 VSS NGO/group operating VSS framework 2
4 Investors Investment advisors, asset managers, assessors,
creditors, buyers, outsourcers
6
5 Policy champions Government, NGO, think-tank 2
6 Consultancy Indian, international 1 each
4 Major findings
In general, there is a need to develop a more conducive and supportive environment that
could facilitate and encourage MSMEs to adopt sustainability standards in their business.
Government is supportive & sensitive towards the needs and limitations faced by MSMEs
in India. At the same time, government is supportive of the sustainability goals and
sustainability standards also. Through subsidies and various schemes, government is
trying to facilitate a better environment for sustainability standards in India. Government
has its own sustainability standards, like ECOMARK that provide incentives and awards
to MSMEs in environment and social performances. But government subsidies and
schemes need to undergo an overhaul to make them more effective and efficient
incorporating international demands and concerns on sustainability.
Certified products market is mainly concentrated in developed countries and growing
at a very fast rate – more than 500 standards are already operational. VSS have
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part II: Micro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 69
substantial power in facilitating a product in the global markets, or barring, expelling or
banning certain products for non-compliance. Role in Global Supply Chain – an
attractive driver for MSMEs to adopt VSS.
MSMEs have a big impact on environmental and social well-being of the country as
they command over large percentage of manufacturing and employment. They also face
pressures of depleting resources on one hand and international sustainability demands
on the other. Adoption of sustainable practices by MSMEs has a great potential to
maximize the development impacts on poverty, environment and other indicators. VSS
can provide direct output to the sustainable development goals agenda.
Scale of operations of MSME is an important factor in decisions regarding VSS. Most
MSMEs operating on smaller scale tend to ignore VSS, even if they are aware. About
73% of all sizes of firms in textile and clothing business are aware of ISO and 65%
know about REACH standards.
Consumer preferences and buyer pressures are the leading drivers for adoption of VSS
by MSMEs. Domestic demand for sustainability certified products is at a miniscule
level in India, mainly concentrated in food & cosmetics sectors, now slightly visible in
textile sector. In developed countries, the demand for certified products is growing at a
substantial rate; in 2012, 3% of the world’s entire cotton was certified, 38% Coffee and
12% Tea was certified. Retailers and buyers have an important role in pushing VSS
down the supply chain.
MSMEs who organize or allocate their resources more efficiently have managed VSS
within their business models. MSMEs responsible towards social-environmental
impacts better suited in adopting sustainability. Better educated, mostly second
generation ownership and management show more drive for VSS. Companies who
invest in learning the know-how and diversification strategies are better equipped to
adopt VSS. There are examples of how Firms took one-step at a time, starting with
water, power and chemicals, made a complete turn-around towards sustainability over
a period of time.
MSMEs are generally attracted towards cleaner technologies as they offer better
savings, efficiency and safety. Cleaner technologies come at a cost that deters small
scale enterprises. Companies adopting innovations in their production and practices are
able to scale up and remain competitive; innovation has helped them in their
sustainability and social responsibility. MSMEs using sustainable practices are helpful
in revival and replenishment of natural resources.
Limited resources and lack of finance are a major constraint for the MSMEs in adoption
of VSS. Smaller firms face maximum impediments in adopting VSS due to their size-
related constraints. Smaller companies often fail to realize their social and environment
responsibilities as more pressure is on the larger companies. Smaller companies also
tend to become risk-averse due to uncertainty of returns in sustainability investments.
Many MSMEs look at sustainability standards as cumbersome & intangible, technically
complex and burdensome due to multiplicities and reporting pressures involved.
The socio-economic, traditional and attitudinal spill-overs in the organization’s
demographics also play a role in its sustainability decisions. Those who are lacking in
strategic management skills, expecting from them to develop a sustainable business
strategy is not fair. Moreover strategic failure is a big risk that MSMEs cannot afford.
MSMEs doing better business in domestic markets or neighboring markets bother less
Shikhar Jain / Archith Ashok
70 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
about sustainability certification. Entrepreneurs, not well aware of sustainability norms
and VSS certification, tend to be misguided by adverse reports, associates, other traders,
suppliers, clients, accountants, etc. Trade federations can play an important role in
spreading correct knowledge and information.
MSMEs established in the industrial clusters caught in a very un-sustainable environment,
due to congested surroundings and pollution, helpless in adopting sustainable standards.
Relocation to new, more sustainable clusters, is an option for them, but it comes at the
cost of losing already existing resource base, suppliers, labor, transport, etc.
International donor support tilted towards sustainability organizations/ operators. Many
of the 500 or so sustainability operators worldwide are funded or supported by one or
the other international donor. Donor organizations find it easier to support the non-profit
organizations operating sustainability standards rather than fund MSMEs directly. The
profit making tendency of MSMEs and foreign currency rules make it difficult for
donors to directly fund the MSMEs.
Domestic funding not sufficient in supporting MSMEs massive requirements. DISHA
and ECOMARK are examples of industry’s own initiatives in sustainability standards.
While DISHA suffers from lack of funding, ECOMARK carries less weightage in
international markets.
Very few revenue models operating in the country that could fund MSME sustainability
investments at recoverable costs. Mainstream banksregulatory implications of standards. Henson and
Humphrey (2009) present a classification of standards that is reduced to these two features
and thus adopted in this paper.
Henson and Humphrey (2009) differentiate most importantly between public and private
standards. Public standards are introduced by national governments or by intergovernmental
organisations and international initiatives, while private standards are established by
individual firms, industry associations and private multi-stakeholder initiatives including
civil society organisations. As indicated in Figure 1, standards can be further grouped into
legally binding requirements (mandatory) and voluntary standards that usually go beyond
legal obligations in order to create high-value market segments and to address ethical
concerns.
In the sphere of public standards, regulations are probably the best known standards.
Government entities seek to protect the safety and health of their citizens as well as fragile
ecosystems by limiting the scope of action for businesses and private actors within national
boundaries. One example is the emission standards for the automobile industry.
Such national legislature is often based on international declarations and intergovernmental
agreements where global issues most prominently climate change, decent work, and trade
are addressed. Since supranational bodies are generally not empowered to enact binding
laws, intergovernmental declarations and agreements establish universal principles that
provide guidelines and international standards of a voluntary nature. Central outcomes for
sustainable business practices of such intergovernmental efforts are, for instance, the
guidelines of the International Labour Organization (ILO) Tripartite Declaration concerning
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German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 3
Multinational Enterprises and Social Policy (ILO MNE Declaration) and the OECD
(Organisation for Economic Co-operation and Development) Guidelines for Multinational
Enterprises, which are meant to be embodied in companies’ corporate social responsibility
(CSR) strategy (IAWG, 2011). Several international initiatives such as the UN Global
Compact, the European Union Strategy for Corporate Social Responsibility, the International
Finance Corporation’s Performance Standards, and the UN Guiding Principles on Business
and Human Rights promote similar sustainability guidelines concerning fair labour practices,
improved environmental performance, and sustainable investment (Giovannucci, von Hagen,
& Wozniak, 2014).
Figure 1: Classification of standards
Public Private
Mandatory
Regulations
Example: emission standards (e.g.
Euro 6, US Clean Air Act)
Origin: national governments,
national standard-setting bodies
Legally-mandated private standards
Example: reference to ISO 9000 in
EU Directive on CE marking
Origin: VSS & national governments
Voluntary
Public voluntary standards
Example: ILO MNE (multinational
enterprise) Declaration
Origin: national standard-setting
bodies, intergovernmental
organisations, international
initiatives, etc.
Private voluntary standards
Example: VSS (e.g. Fairtrade, FSC
(Forest Stewardship Council),
GlobalGAP), CSR, ISO 26000, etc.
Origin: industry associations, CSR
of individual firms, multi-stakeholder
initiatives of civil society/firms, etc.
Source: Based on Henson and Humphrey (2009)
Private standards have mainly emerged as a reaction to globalisation. The continued
internationalisation and fragmentation of production processes have made standardisation
necessary. Initially, private standards were concerned with compatibility and quality of
intermediaries and final goods so that standards predominantly focused on the product and
its features. Much of this work was done by the International Organization for
Standardisation (ISO), a non-governmental international organisation that develops norms
for products, industries and sectors. The introduction of the ISO 26000 standard on social
responsibility in 2010 reflected the general evolution of private standards that had already
started in the late 1990s: private standards increasingly included an orientation towards the
production process in order to account for consequences for workers, the local community,
and the environment.
Spurred by both growing consumer awareness with regard to sustainability and mistrust in
the ability of intergovernmental processes to guarantee sustainability in global supply
chains, civil society organisations began to start up inclusive multi-stakeholder initiatives
such as Fairtrade to increase transparency in global trade by certifying products that
complied with given sustainability criteria. Such voluntary sustainability standards (VSS)
define sustainability practices and audit participating producers and firms through
verification or third-party certification. VSS operate under the premise that any and all
actors should adopt the standard, that is, VSS generally apply to entire markets and across
national borders (Potts et al., 2014).
Christoph Sommer
4 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Pressure from civil society organisations and conscious consumers in combination with
growing corporate awareness have strengthened the spread and practice of CSR, which allows
firms to secure a good reputation for their brand along with profitability through product
differentiation and access to high-value segments of the market (Giovannucci et al., 2014).
While private sustainability standards are almost exclusively of a voluntary nature, within
particular markets market forces may render voluntary standards de facto mandatory (even
if there is no legal penalty for non-compliance) (Henson & Humphrey, 2009). In some cases
of co-regulation, the legislator also passes legislation relating to particular private standards
or refers to private standards so that VSS become legally binding. These two situations already
explain why the classification of standards is not straightforward but in fact blurred: VSS may
become de facto mandatory or even legally binding and thus part of public regulations. The
spheres of public and private standards are truly interconnected as, on the one hand, firms
may incorporate public standards and regulations into their CSR strategies while, on the other,
local VSS may adopt national regulations. Lastly, firms may also adopt VSS into their CSR
strategies. This means that while the classification of standards may provide a general
overview of standards and their origins, one must remember that these are subject to constant
change and that boundaries are blurred.
The following part outlines how internationalisation of production and growing
sustainability concerns have fostered the spread of standards. Integration into GVCs and
supply chains also confronts SMEs with social and environmental standards.
The growing importance of global value chains and sustainability
Global value chains comprise of diverse firms that contribute to the final good or service
through intermediate inputs. The rising share of intermediary goods in global trade, which
already accounts for more than two-thirds of trade, underlines how GVCs reshape trade
patterns in a world of ever more interdependent and interconnected economies. Global value
chains increasingly involve developing and emerging economies in global trade, as lower
transportation costs as well as improvements and diffusion of information and
communication technologies (ICTs) allow GVCs to move production to where it is most
advantageous, exploiting, for instance, the comparative advantage of labour- or resource-
abundant countries. Hostand financial institutions lack skills
and manpower to deal with sustainability standards. Most financial institutions follow
fundamental principles of ROI and see no tangible returns in sustainability standards
funding. Maximum challenges are faced at the grassroots where access to market and
access to banking are still not smooth. Plethora of competing standards and resulting
escalation in transaction cost are negative factors for bankability of the projects.
Majority of MSMEs argue that buyers do not share the cost of VSS while they keep
pressing for lower costs. Low prices of commodities are a major concern of the
producers. One time cost incurred by manufacturers not properly distributed throughout
the value chain.
Growth of VSS is coincidental with global efforts on Sustainable Development Goals
(SDGs). MSMEs are important engines of new development paradigm given their
reach in the areas of high need. UN Sustainable Development Goals Fund (UNSDGF)
is a great way of looking forward. The fund finally enlists MSME contribution in the
development agenda. However, UN faces challenges, like, infrastructure for engaging
with MSMEs, UN’s own decreasing funds, focus shifting to larger enterprises rather
than MSMEs, and uncertainty in private finances for public good (which UN is
targeting under UNSDGF) which may create impediments in promoting SGDs through
MSMEs.
Credit for micro-finance and rural-finance is a novel way of going forward for MSME
funding. It will also increase inclusiveness at the grassroots levels one the major
requirements of sustainability. But higher and uncontrolled interest rates prevailing in
micro-finance may not be attractive for MSMEs.
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5 Defining voluntary sustainability standards (VSS)
The VSS are voluntarily adopted rules, procedures, and methods to systematically ensure
better social and environmental behavior and performance of firms (Gilbert et al., 2011, p.
24.) Most VSS are non-legal in nature, operated by non-state actors (Abbott et al., 2000).
As conventional production and trading practices can be detrimental to the stability of
resources, environment & communities in the long run, sustainability standards have
primarily emerged as people’s response to these environmental and social concerns.
Mainly concentrated in developed countries, consumers’ demand for products that are not
harmful to people and the environment is a major driver of sustainability standards.
Sustainability standardization is a mechanism that could promote trust in the entire value
chain, especially between the producers and end users. Compliance of businesses with
sustainability standards can demonstrate that goods have been produced in accordance with
the principles of sustainable development. A large number of commodities worldwide are
certified for adhering to the sustainable standards and certified markets are growing at a
very fast rate.
Sustainability standards are developed, operated and monitored by well-organized
sustainability organizations represented by NGOs and civil society groups. Sustainability
organizations derive their legitimacy from their genuine concerns for social, labor,
environmental, economic and business sustainability. Most organizations operate through
multi-stake-holder participation and have an independent certification process.
This section offers a brief summary of the basic characteristics of some of the leading
sustainability organizations, mainly in textile sector that we studied in this report, and their
core objectives.
Better Cotton Initiative (BCI) – The objective of BCI is to make global cotton production
better for the producers, better for the environment, and better for the sector’s future.
Clean Clothes Campaign (CCC) - The objective of CCC is to improve the working
conditions and status of workers in the global garment industry. They hope to end
suppression, exploitation and abuse of the workers in this sector, especially women workers.
Disha Common Code of Conduct (DCCC) - AEPC (India) is committed to increasing the
export potential of Indian garments industry. The sustainability standards promoted by
AEPC were aimed at increasing sustainability and expansion of global markets, by bridging
the gap between the exporters and buyers through sustainable practices and quality
management system.
Fairtrade International - Small Producers Organizations - Fairtrade’s objectives are to
connect small, marginalized and disadvantaged producers with consumers and promote
fairer trading conditions and empower producers to combat poverty, strengthen their
position and take more control over their lives. It promotes transparency, sustainable
practices and stakeholder participation at different levels.
Shikhar Jain / Archith Ashok
72 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Forest Stewardship Council (FSC) - The FSC’s objective is to promote environmentally
sustainable, socially beneficial, and economically viable management of the world's forests.
Global Organic Textile Standard (GOTS) - The Global Organic Textile Standard aims to
ensure organic status of textiles, from harvesting of the raw materials, through
environmentally and socially responsible manufacturing up to labeling in order to provide
credible assurance to the consumer.
Good-Weave – Good-Weave International works to ensure child labor is not used in the
handmade rug industry.
IFC Performance Standards on Environmental &Social Sustainability - A World Bank
Group, IFC’s mission is to end poverty. Its objective is to help people help themselves and
their environment by providing resources, sharing knowledge, building capacity, and
forging partnerships in the public and private sectors, grounded in sustainable private
investment.
OEKO-TEX® – OEKO-TEX has developed a reliable product label, OEKO-
TEX®Standard 100, for consumers who specifically buy textiles which are harmless to
health. It has introduced a testing and certification system that satisfies varied requirements
of consumer preferences and complex production conditions. It promotes among other
things sustainable labor practices, disuse of harmful substances and discouraging use of
ecologically harmful textiles for the humans.
Sustainable Agriculture Network (SAN) - Rainforest Alliance - SAN promotes
environmentally sound, socially equitable and economically viable development that
ensures sustainability, recognizing well-being of societies and protects ecosystems.
The EU Ecolabel – Ecoladels encourage organizations towards making environmentally
friendly products. Certain European nations have stringent quality and sustainability
standards and Eco-Labels certify that products entering EU markets fulfill those standards.
Eco-labels are popular among the consumers of some EU countries. In some sectors, such
as textiles, having an Eco-Label certificate guarantees better returns for the businesses.
1) Role of Voluntary Sustainability Standards in global value chains
Voluntary standards institute rules for all the participants in the value chain. A common
objective of the VSS is to enhance the sustainability of production and consumption.
Implementing organizations of these standards are formalized through their board of
directors, committees or secretariats. Some impacts and benefits the VSS bring to the value
chain participants are discussed below:
- VSS give a surety that a product has been brought to market using sustainable
production or trading methods, and not just focus on the physical quality of the product.
- VSS Verify labor standards and environmental protection norms.
- VSS infuse more information andknowledge (about the production methods, raw
materials, sustainability criteria etc.) into the value chain and up till the end consumers.
- VSS help in segregating products and practices that follow sustainability standards from
those which are not certified for sustainability standards.
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- VSS play an important role in establishing terms of contracts and value of certified
products. E.g. Fair-Trade certification standardizes a minimum price that developing
country suppliers must get.
- VSS help in structuring management practices in production processes and facilities,
ensuring that important national and international conventions for labour, health &
safety, environment and social well-being are met.
- VSS operators take part in auditing and verifying the compliance of the standards in
production processes. The auditing and accreditation bodies have the power to admit,
suspend or expel enterprises from certified value chains.
As discussed earlier, a large number of commodities today are certified for sustainability
standards and certified markets are growing at a very fast rate. In this scenario VSS have a
very important role in global value chain decision making process. They have substantial
power and authority in barring, expelling or banning certain commodities from entering
into the certified markets.
2) Micro, small and medium enterprises (MSMEs) and Voluntary Sustainability Standards
MSMEs are crucial to the growth and stability of the global economy. They command large
percentage of manufacturing operations and employment. Their social and environmental
impacts are noticeable.
Due to depleting natural resource base and environmental degradation, MSMEs are
increasingly being faced with pressures to adopt sustainable means and methods in their
activities. MSMEs are an integral part of the supply chain, and the growing demand for
sustainability from their customers and suppliers is a double edged challenge for a large
number of MSMEs. It affects their access to resources (labour, raw materials, machinery
and finance) and their access to markets.
That said, many MSMEs still feel they can ignore addressing sustainability issues. MSMEs
are tied up in more urgent issues at hand and sustainability standards don’t take priority in
their list of urgent tasks. But in the long run, MSMEs may not be able to push sustainability
demands any further. The growing international and domestic demands for sustainable
practices in production may see their products go off-the-shelves if not responsibly
produced.
The biggest hurdle facing MSMEs in integrating with VSS is their limited financial
capabilities. Initial cost of integrating sustainability into the existing business model is high.
Although these costs get offset by the benefits of sustainable standards, but it takes a long
time before the costs are recovered. Positive brand association, expanded consumer base,
new investors, and expanded supplier base are some of the added benefits MSMEs get by
associating with VSS. But a majority of MSMEs fight a daily battle for resources and
survival. They need short term returns to carry on their businesses.
Shikhar Jain / Archith Ashok
74 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
6 Perceived impacts of integrating VSS in MSME
A close analysis of the objectives and outcomes of several relevant voluntary sustainability
standards reveals the benefits and impacts of the VSS on the businesses, environment and
social concerns. The VSS positively impact the United Nation’s agenda of the Sustainable
Development Goals (SDGs).
A sincere approach of MSMEs towards VSS can make promising impacts on development
indicators identified by the UN; poverty, health & education, water, sanitation, clean energy,
sustainable cities and industrial growth, decent work and gender equality, economic growth,
innovation and infrastructure development, reduced inequalities and community
sustainability, partnerships and environmental protection.
Strengthening MSME’s in sustainable production can help extend and expand the new
development agenda. Some of the impacts of this approach are highlighted below:
Market access – Sustainability standards such as FairTrade and Better Cotton Initiative
promote access to markets for marginalized farmers. The organizations adopting their
standards need to invest in working with farmers and intermediary producers. As many
markets are interconnected, VSS also impacts labor markets, input markets, access to credit
and financial services, fertilizer, seeds, technology etc. Therefore, promoting VSS that
impacts markets access for small producers achieves an important development goal.
Increased returns – A number of impact studies point out that organizations which
participate in VSS gain price premiums and higher yield, and related improvements in net
incomes. Usually, when adopting new sustainable standards, producers positively get
benefited from factors like agricultural yields, production efficiencies, energy savings, labor
efficiencies, etc. All these factors contribute in increased returns, not only for the certified
industry, but all the participants in the business down to the last person in the chain, the
primary producer. Therefore, producers could provide better returns thus bridging
inequalities in earnings and livelihoods, up to the lower end of the pyramid.
Inclusion and technology transfer – Several studies have shown that integration of VSS
by producers creates inclusiveness to a great extent. Producers, and suppliers from the lower
end, have improved access to credit and technical know-how by adopting VSS. MSMEs can
create conducive conditions for inclusion of primary producers in sustainable certified
product chain, fulfilling an SDG agenda of inclusive development and equal opportunity.
Poverty alleviation – Several VSS have been established with the goals of improving the
plight of the poor, marginalized farmers and small producers while promoting sustainable
practices. Several studies provide insights into how adoption of VSS impacts poverty
alleviation and equitable development as a commitment by the producers. Poverty is a major
SDG agenda and MSMEs play a very important role in employing almost half of India’s
working population, mainly from the lower end of the economic pyramid. Integrating
poverty alleviation standards (e.g. training of farmers and primary producers) by MSMEs
will be also be adoption of an important SDG goal. As large number of MSMEs operate at
the grassroots levels, this will benefit some of the most economically backward and
disadvantaged regions of the country.
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Ethical labor & wage practices – A significant number of individuals are employed as
wage labor by MSMEs. The proportions may differ based on the site and commodity, but a
large number of farm laborers are also part of the value chain. Some studies have found that
those who work in VSS certified firms and farms perceived they as better off compared to
those who worked on non-certified ones. They feel comparatively safe and think their
environments and surroundings are healthier.
Gender equality – A few positive instances have been sited of women’s empowerment due
to participation in VSS. An ITC report states that “female participation in farm activities
and decision-making is less in farms associated with non-VSS standards”. As per Census
2011, the work participation rate for women is 25.51 percentin India. The wage per man
day worked in 2008-09 is Rs. 258.04 for male and Rs. 131.23 for female (Source: Labour
Bureau). While just 12.7 per cent of the working women were in regular wage employment
32.1 per cent were employed as casual labor in 2011-12. The voluntary standards adoption
by MSMEs can increase potentials for employment of more women in regular wage labor.
Health and education –Some studies have shown improved outcomes in food consumption
as well as “health and education” among VSS linked producers; farmers & wage laborers.
They compared individuals hired as wage labor in FairTrade as well as non-Fairtrade sites
and compared their educational attainments and dietary intake and found discrepancies
amongst Fairtrade and non-Fairtrade wage –workers. To measure educational outcomes, the
researchers used access to child-care and scholarship programs as indicators and found a
positive impact of VSS on these parameters.
Environment
Environmental impacts broadly cover topics such as resource management, soil
conservation, bio-diversity and water quality. Studies conducted by ITC and others notes
positive outcomes in the area of soil conservation on Coffee plantations, levels of resource
degradation and soil erosion where FairTrade was involved. Studies by De Lima et al
(2009), noted a net positive impact of VSS on deforestation.
The more important question here is not whether VSS promote adoption of sustainable
practices by the producers, but does VSS really make an impact on sustainability itself? By
improving profitability, business opportunities, socio-economic development and
environment VSS demonstrate their value for sustainable development. As MSMEs are well
placed in the value chain as well as in the society, a wider adoption of sustainable practices
by them has great potential to maximize the impact and achieve the sustainable goals at a
much faster rate. Therefore, MSMEs are not only the engines of growth but also engines for
sustainable development.
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76 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
7 Case studies
1) Appachi Eco-Logic Cotton Private Limited
A number of small businesses are already reaping the profits of standards use. Pollachi
based, Appachi Eco-Logic Cotton Private Limited has long been committed to promoting
inclusive growth in its Farm to Fashion value chain using Better Cotton Initiatives and other
standards.
The company, led by its promoters, Mani Chinnaswamy and Vijayalakshmi Nachiar, has
successfully integrated 2,000 farmers spread across 2,000 acres into the organic project in
the endangered ecology of the Kabini Reservoir region. The group has been involved in
cotton trading for more than 6 decades and is well known for the Extra Long Staple (ELS)
Cotton and Suvin. With Mani’s extensive work with small farmers, the company was the
first to introduce cotton contract farming in the region along with crop insurance for farmers.
Appachi Cottons has also improved farmers’ livelihood by providing non-BT seeds,
sanitation and access to education.
When Mani, an MBA graduate from the USA, inherited family’s cotton mill, took a
conscious decision in 2006 that they should be an “ethical” business. They quit their
conventional business methods and adopted sustainable methods.
It was a decision driven by concerns for cotton farming in India, which was losing its age
old organic farming culture, with overuse of fertilizers, failing soil, subsequent crop loss,
farmers moving to GM crop because of low yields, farmers being in debt, leading to suicides
and so on. The Company realized that the perception in international markets was that Indian
cotton was one of the most polluted. “The solution was to reviving the Soil, going back to
organic”, they thought. This is how their Eco-Logic Project started.
They have about 165 farmers in their network now. They don’t offer farmers a pre-fixed
price, but a minimum support price; else, a market committee is formed that fixes the price
in keeping with market rates.
Weavers too have the same sad story as farmers; the weavers work for a wage; get no
recognition for their work; and so don’t want their children to continue in the profession.
That’s when the idea of value addition came in. The couple built a 22-room studio with
traditional jacquard looms. They roped in designers to work with weavers. Each of their
products carries a tag with a picture of the weaver, his name, how long he took to weave it;
they have over 50 weavers working with them now. They also started a free-education
school for the children of weavers.
But how do they fund their sustainability inputs. “Look at this way, you, as a customer, paying
a ‘conservation contribution’. We pay 10 per cent over what conventional cotton farmers get
for their produce”, informs Mani. The farmers do multi-cropping and so earn a little more
from the organic farm. The company raises resources by exploring new markets and new
products. The company saw another business opportunity and started the Eco Logic Tours!
Appachi has not only established its own unique identity, but also ensures that people
involved in its value chain, get their due recognition and adequate reward. Entire value
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addition chain adheres to the ethical business practices to ensure that the cotton farmers,
weavers, workforce and the end users benefit from the same. Over 750 hectares of land,
1200 small holder farmers, households, 100s of tailors and handloom weavers have
benefited through the project. The journey connects farmers, ginners, spinners, artisans, the
textile value chain and finally the consumers.
Appachi shows an innovative way to the small businesses in developing regions of the
world. The key to success lies in the organization’s willingness and capability in identifying
and adapting change. Innovative, efficient use and ensuring revival of available resources
bring everyone in the chain better returns and sustainable market access.
2) Tirupur – A case study of struggle & turnaround of an entire cluster towards sustainability
Tirupur was a job working center and not a brand exporter. This meant that most of the
exporters take up job work for brand marketers in developed countries and do not sell their
own brands. Year 2006, the power supply was erratic and the town was prone to frequent
blackouts. A majority of the industrial units were on diesel generators to provide stand-by
power. The piped water supply was hardly adequate and the limited water was insufficient
even for household requirements. There was no underground sewerage system. The
industrial effluents were carried through open drains into a dry river called Noyel. The
wastewater was carried to a reservoir built for irrigation purposes, about 15 km away.
During its journey to the reservoir, a part of the wastewater permeated through the soil and
contaminated the groundwater.
Water was a major requirement of the industry. As the area was dry and much of the
groundwater was polluted, over half the water required by the industry was brought in by
trucks from groundwater sources at distances of over 50 km. The industry paid around
US$ 6 million annually to bring the water by trucks. In addition, the lure of quick money
tempted small farmers to sell the water to the industry instead of using it for farming. The
other half of the water requirement was met from the few bore-wells where water was still
of good quality. However, the groundwater table was going down rapidly.
The industrial effluents were drained out untreated into a dry river. A substantial part of the
effluent leached into theground through its passage to the reservoir. The water was saline,
highly colored and contained toxic dyes. The entire agricultural operations in the
neighborhood had been badly affected by the groundwater contamination.
The consumption of firewood by the industry was over 437,760 tonnes per year. The firewood
was brought in by the felling of trees from the nearby Nilgiri Hills. The wood cover in the
Nilgiri Hills was rapidly depleting. The steam calendaring industry was using over half of this
quantity, for steam generation. The bleaching and dyeing industry was using the rest. The
firewood was being used in inefficient boilers at 850 different production centers.
Nearly 40 tonnes of combustible solid waste was generated every day by the textile industry.
This comprised paper and textile scrap (rags and threads). This has a high fuel value. In
addition, an estimated 250 tonnes per day of municipal waste was generated by the industry
and the households.
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78 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
The situation in Tripur was not sustainable and turning to worse. In 2009 the business started
drying up due to global economic meltdown. Clients from foreign shores stopped orders as
their pockets emptied. In February 2011, Madras High Court banned all dyeing units in
Tirupur for violating pollution norms. They would only be reopened when they
implemented zero-discharge protocols in order to protect the surrounding farmlands and
rivers. The smaller players were hit very hard as they work with limited capital. Companies
drastically scaled down and small timers simply went out of business.
State government records show that close to 40,000 families working in the garment units
surrendered their ration cards and headed back to their native villages in the southern
districts in search of employment.
The turn around
Reeling from the blow by the Madras High Court, large and small businessmen quickly
came together to find a solution. There was now an urgent need to voluntarily invest in
pollution control norms. Through a series of trial and error, they borrowed technology from
various parts of the world and came up with their own version of effluent treatment plants.
Larger manufacturers set up individual plants to process their waste, while smaller units
came together to route their polluting effluents through a single central plan. Today, there
are 18 Central Effluent Treatment Plants in Tirupur.
The magnitude of resources flowing through the system made the businessmen anxious as
now they bothered for each penny. Each small industrialist was paying a small amount for
buying water every day and the costs had been internalized into the product cost. It was
obvious that water recycling could be both an economically viable option and a solution to
the environmental problems. A private entrepreneur came forward to explore the business
possibility of using the waste heat from the boilers in the dyeing units to serve as the energy
source, and to recycle the wastewater. A prototype was ready in six months. A commercial
plant was readied for marketing and its use is now proliferating. By the last quarter of the
year 2000, over 40 units had already installed these plants.
Currently around 92 per cent of the water that is discharged as effluent is recycled and
reused. They are also recycling the salt used. Only 0.5-1 per cent of the dye used is removed
in the treatment process and sent for use in cement factories. The Tirupur industries have
attained zero liquid discharge.
Some challenges
All of this has come at a price. Grants from the Centre and the state government of Tamil
Nadu totaled Rs 300 crore. The state government also arranged for interest-free loans to
industry to the tune of Rs 200 crore. Out of a total of Rs 1,070 crore, close to Rs 600 crore
was pumped in by industry and private loans from banks. Power usage too went up as a
result of the treatment plants.
As a result, the industry as a whole became less competitive. There was an additional 4 per
cent hike in the final garment price that the industries had to bear.
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However in the long run the industry stands to recover from these loses. The rich availability
of the raw material, being in close proximity, is assured as more water is available to the
farmer now. Moreover the opportunity cost of water, which was very high as the individual
industries were spending a substantial amount on it, with recycling may compensate the cost
of power.
Better sustainability practices has helped Tirupur based MSMEs a better leverage in the
international markets. The Tirupur Exporters Associations (TEA) has emerged as a dynamic
association of more than 500 MSMEs. The association helps industries establish a direct
contact with buyers, disseminate market and demand information through their
dissemination materials, has set up training & learning centers, apparel parks and
sustainability linked institutes such as, Women Entrepreneurship Training center. Similarly
Tirupur Dyers Association is promoting sustainability, in effluent management and training,
through 750 of its operating members. Through all these mechanisms, individual industries
are coming together to promote common brands as collective adoption of sustainable
practices gives differentiated advantages to the industry in the international markets and
opportunities to access potential customers.
8 Factors driving adoption of VSS by MSMEs
It has been proven that adopting the standards is beneficial for all types of businesses; small
or large. The strategic use of standards can significantly increase their market access,
turnovers and profits. Collective adoption of VSS by a group of industries has an
extraordinary impact on the entire sector and resource base.
Standards improve the global competitiveness of the firms and open up the export markets,
improve their operational efficiencies and increase customer confidence in their products.
With the emergence of sustainability concerns in the global value systems, the environment
for information and adoption of VSS has also increased in the recent years. We need to look
at and record factors that drive actors to engage with VSS. Why do farmers, forest owners,
factories, would want a certificate? They need to be motivated and ready for the same.
Factors like demand, vision, and need are definitely factors which will contribute in
MSME’s decisions for going sustainable, provided they see a positive impact on their
growth. Collectively for the entire MSME sector growth is a major factor that will drive
them towards the adoption of standards. We briefly discuss a few drivers that promote the
sustainability standards.
1) Consumer preferences
In recent years there has been a sharp increase in the numbers of certified products. In 2012,
38% of the coffee sold on the world market was certified, 12% of the Tea and 3% of the
Cotton was certified (Potts et al., 2014 p. 90).
Consumer demand is the strongest driver for VSS in the context of Indian textile business.
Interacting with a small scale apparel manufacturer, Shazia International Limited (SIL), it
could be easily deciphered how the textile industry has gone a sea change in the recent years.
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When SIL started out about 28 years ago, they had ample work outsourced from the large
export houses in NCR region of Delhi. SILs turnover was touching 2-3 crores annually.
During 2005-6, SIL’s business scaled down as they failed to comply with demands for
sustainableproduction methods. SIL failed chemical tests and could not source certain safe
listed raw, their energy usage was also questioned by the assessor. When SIL’s orders
completely stopped they were forced to depend on the domestic markets for survival. Now
realizing the potential of sustainable, SIL is promoting another company by the name of
Bandwagon, under the leadership of their owner’s MBA Son, and is looking for launching
their own organic products as they realize that consumer demand for such products is growing.
The consumer demand for sustainable products is going to be the future for all businesses.
Start Up companies like Organic Clothes India (OCI) have identified the consumer need for
environmentally friendly products as a major growth potential. The company believes that
consumers expect sustainability and social concern as a matter of basic business practice
and Organic is a great way to implement it. The company has a range of organic products
including bamboo clothes, herbal and natural clothes. Their products carry several
Certifications including Global Organic Textiles Standards (GOTS), and the American
International Accreditation Organization (AAIO – BAR).
2) Market forces (international & domestic)
A study conducted by CUTS-CITEE, identified, ‘better acceptance of products in
international market’, as a most important reason for producers to subscribe to sustainability
standards. The survey in India points out that among several environmental standards, the
majority of respondents (73%) are aware of International Organization for Standardization
(ISO) and about 65% know about Registration, Evaluation, Authorization, and Restriction
of Chemical (REACH). Export potential of the textile and clothing firms in India is highly
dependent on sustainability standards certification and environmental compliances.
According to Gurgaon based consultant, Rajesh Bheda, “there are about 6000 registered
exporters and around 20,000 manufacturers associated with exports of textiles from the
country today”. He mentions that a large number of these are MSMEs, some directly linked
with exports and some exporting via third parties. He further points out that export trade is
a major driver for adopting sustainability in textile business as exports do increase with
environmental and sustainability compliance and there is less uncertainty in market access.
As Mr. Rajesh Bheda mentioned, a large number of textile and clothing firms of all sizes
comply with standards such as REACH and GOTS as they are applicable to the EU, which
is a major export destination for these firms.
The international buyers, especially large retailers, are driven by a strong demand for
products which are certified according to sustainability standards. For example, Marks &
Spencer, aspires ‘to become the world’s most sustainable major retailer by 2015’ (Marks
and Spencers, 2010, p. 3). It uses a VSS system. Retailers have an important role and
decision making power in global supply-chains (Hamilton, Petrovic, & Senauer, 2012).
They have a power to pushing through voluntary standards down the supply chain to all
actors involved in the production process.
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3) Resources
Mr. Rajiv Baruah of Better Cotton Initiative, identifies resources as an important reason
why producers are now turning for certifications. He says that buyers and retailers pressurize
the producers but don’t pay any cost towards sustainability. In this scenario for the large
scale organizations going for sustainability certification is not an easy decision.
Comparatively, it is difficult for small scale producers; hard pressed for resources, only
those who could manage to divest some of the resources for adopting sustainability
standards are doing it. Most successful are those who see resources as not a means and end
to everything but try and leverage all the resources available to them towards their
sustainability commitments. For examples, those firms who have focused on cultivating a
better trained producer network automatically become part of the sustainable value chain.
E.g. firms who invest back in reviving the natural resource base, through training of the
farmers, ensure better soil quality and water use, and better returns in a sustainable manner.
Those organizations who have freedom of resources are well placed for taking the risk that
comes with investing in new technologies as they are not worried about the long payback
period generally associated with sustainability investments.
4) Leadership & management know-how
For SMEs, going sustainable is largely a voluntary decision dependent upon the vision and
conviction of one or a few individuals. The entrepreneur plays a key role in the enterprise
and his personal preference, knowledge and exposure are usually the most influential factor
when deciding about investments and business strategies. Those MSMEs are better placed
in adopting VSS whose leadership and management are concentrated in the same hands, are
better educated of the trends and benefits; mostly those led by second generation owners or
second line management.
In the example of Appachi Cotton, the second generation owner of the firm, a western
educated MBA, took the firm decision of stopping all the traditional methods of business
and adapting to an entirely new sustainable methods.
Many MSMEs willing to invest in more energy efficient and environmentally friendly
processes are able to do so if they have specialized human resources needed to implement
these decisions. Availability of appropriate skills and expertise encourages these firms to
act upon and benefit from opportunities brought by VSS.
5) Technology
MSMEs that integrate sustainability into their core business strategy can benefit from lower
costs, reduced risk, and new opportunities. Technology plays a very important role in this
integration.
Even when there is no buyer input for general sustainability such as water, energy and
chemical management, many MSMEs are adopting new technologies in these areas as they
promise better returns on account of higher efficiencies and lower losses. There are some
experts advising the businesses on revenue model linked sustainability transformation.
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A number of MSMEs have set examples of how they transformed their business into
sustainable models over a period of time taking one step at a time. Starting with water;
reducing wastage by recycling and reuse; adopting cleaner chemicals, they moved to more
complex issues such as solar and other energy-saving solutions, energy efficient production
lines, lean management techniques, and so on.
The MSMEs are attracted to the cleaner technologies because this brings multiple benefits
to them. Clean technologies promise higher revenues due to less wastage, longevity, safety
of the workers and lessor adverse impact on the environment.
6) Innovation, scale & competition
At a time when changing buyer/consumer attitude towards sustainability is creating
problems for the MSMEs to remain afloat, there are opportunities also. As the economy
changes color and traditionally flourishing markets become constricted, smart companies
adopting innovation can retain their profitability.
As the saying, “need is the mother of all inventions”, innovation is a blessing in disguise as
it helps the companies scale-up and beat the competition. For example, Textile Recycle
Association is promoting recycling and reuse of the clothing. Some very high street vendors
such as H&M and Marks and Spencers are also part of this campaign. They collectunwanted
clothes in-store and distribute to charity. These are converted into rugs, made into other
clothing, or cleaning clothes. Many small players are venturing into ethnic and traditional
rugs made from recycled items.
Another example is how some organic textile firm are experimenting with bamboo fiber and
other natural and herbal materials in their clothing.
9 Constraint for MSMEs in adopting sustainability standards
So what are the constraints that MSMEs face in adopting the voluntary sustainability
standards? Although, a number of respondents have linked low financial resources as a
major impediment, however, we will discuss several other constraints as well in this chapter.
In the next chapter however, we will try to deal at length on what are the urgent financial
demands for VSS in the MSME sector.
1) Size related constraints
It is still a challenge for smaller companies to participate in the standardization debates and
hence they lose on the knowledge and urgencies involving sustainability. Smaller
companies cannot commit their workers to represent at the sustainability forums.
Most MSMEs, particularly the smaller ones, lack the necessary human resources to devote
into developing long-term strategies, finding right kind of solutions, resources, etc. Their
management is largely involved in daily operational practice, and there is no time for
activities not directly related to the daily business. They are forced, therefore, to a short-
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term view of their business and are limited in their actions on future-ready regulations and
standards.
Size of a company also impacts its perceived social burden. Smaller companies in
singularity are seldom identified as responsible for depleting resources or harmful impacts
to the environment because their impacts may appear small. On the contrary MSMEs by
nature contribute to sustainability by employing the masses and producing for low budget
markets. But the collective impact of MSMEs on sustainability is the same as larger
conglomerates. A responsibility they overlook.
Smaller firms mostly remain out of the direct purview of mounting global pressures as the
focus there also remains largely on bigger firms. This also means that global sustainability
debate has kept MSMEs out of the development agenda.
2) Resource constraints
The willingness and capability of SMEs to adopt sustainable practices generally face
resource constraints, skill deficit and knowledge limitations. MSMEs are often unaware of
many schemes and opportunities that are associated with sustainability standards
framework. Many MSMEs see sustainability as a cumbersome process associated with
technical complexity, burdens and usually very high costs. Lack of resources often leads to
MSMEs being risk-averse and less willing to invest in new technologies.
A 2014 German Standardization Panel report identified financial constraints as a major
hurdle for small scale enterprises in adopting sustainability standards. Most MSMEs in India
work on limited financial resources. They are less willing to wait for the return on their
investments. Therefore it is difficult to convince them make investments in technologies
and practices that will pay them in the long run. They may be convinced of the future
benefits of going sustainable but often it’s a question of their survival.
3) Attitudinal, cultural and traditional challenges
Attitude is a mental state systematized through knowledge influencing upon individual’s
response to objects and situations around which it relates (Allport, 1935). Culture, one of
the main sources for the formation of attitudes, includes generational, social, legal and
institutional experience (Douglas & Pratkanis, 1994). Business decisions and enterprises
very much depend on attitudes and cultural dispositions of the entrepreneurs and workers.
Indian MSMEs work within the socio-cultural ecosystem of India. Many of the MSMEs are
working in the rural areas of the country where traditions are not very favorable for several
groups (e.g. women taking up jobs travelling long distances to work). There are seasonal labor
variations that the MSMEs have to deal with on account of predominance of agrarian
societies.
The socio-cultural and traditional spill overs are very much visible in the organizational
demographics and life-cycles. It is demonstrated through how the enterprises deal with
events such as festival breaks, group dynamics, divergent behaviors and stubbornness of
certain groups in their production and management lines. For traditional enterprises it is not
easy to break from their old traditions (and situations) and adopt entirely new systems
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without resistance and frictions (for example, introduction of computers in public and
private sectors alike was looked upon as a threat by the employees used to working in
traditional ways). Any disruption in the usual calm and ease of an organization has a risk of
attracting resistance. And this is a discouraging factor for adopting sustainable systems by
many MSMEs in their existing structure.
4) Technological and infrastructural challenges
Existing MSMEs operating on old technologies and traditional practices need
transformative approaches if they wish to adopt sustainability standards. Many of them will
need to discard their existing infrastructure and adopt an entirely new set of infrastructure
all together. They will need to set up new plant and machinery; more energy saving, water
and environmentally friendly. They will have to create better and healthier working spaces
for their labor force. Decisions for discarding machinery and tools also, such as boilers,
looms, fittings and fixtures, in many cases which have taken a life time to establish and
master, is not an easy decisions if growth and profits are not clearly demonstrated. Smaller
players would go on using their inefficient infrastructure for their already guaranteed short
term profits.
MSMEs will have to invest in training of employees to use new technologies and methods.
In many cases they will need to change their supplier base (to ensure sustainable raw enters
the business). They will need certain technologies which most likely will not be easily and
economically available within the country. With limited financial avenues, it is difficult to
persuade MSMEs to make that kind of investment in something which has no immediate
returns and whose benefits are mainly looked as social or environmental good by a large
number of small industries.
5) Locational challenges
A large percentage of MSMEs in India are located in ‘ghetto’ like geographically located
‘industrial clusters’ where they face cut throat competition due to mushrooming of copycats
and ‘marginal-rate’ operators. Their challenges get multiplied due to unhealthy
environment, lack of regulation and poor infrastructure prevailing in many of the clusters.
Industrial clusters in India are generally facing acute problems in terms of infrastructure
such as transportation, congestion, power and pollution and in terms of human resources
such as unionism, alcoholism and reverse-migration.
Congestion and pollution pose health hazards to the labor living in surrounding areas. Labor
colonies converting into urban slums compel workers to low standards of living. MSMEs
operating in such congested clusters can’t do much about sustainability because the very
environment surrounding them is in contravention to the requirements of sustainable
development goals.
A number of Court orders, and national green tribunal reports, in Indiahave declared several
industrial clusters as hazardous. Some clusters are directed to be shifted to other places
where they could be sustained. Relocation is another challenge for smaller firms as new
areas will pose them with new challenges in labor sourcing and transportation.
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6) Strategic limitations
MSMEs face a number of operational issues within the organization, such as the capacity
to absorb and implement new systems and methods, uncertainty about the most appropriate
technology to be used and simply a lack of knowledge about how sustainable practices can
be incorporated in their business planning. Many MSMEs, operating on their daily business
needs, may not be having a strategic plan for their business altogether.
Strategic failure is another risk that MSMEs will avoid taking. The product or the processes
they chose may not turn out to be that profitable or that sustainable as previously thought
and they might lose the right to very Certification that they took all the pain for. Again, for
developing an effective company strategy, most MSMEs would require outside support and
consultants that a majority of them cannot afford.
Moreover, sustainability certification is not an attractive option for an MSME if it is already
doing well in non-certification markets, e.g. domestic market or neighboring markets. They
see no clear incentives in the lengthy and complicated certification process.
Again, most MSMEs are largely driven by a single entrepreneur or a small group, very likely
tied in time and task pressures. Reflecting on strategy and future sustainability does not
figure in their tight schedules. Thus the concerns related to voluntary sustainability
standards, considered ‘extra’ inputs by most entrepreneurs take a back seat. Sometimes
entrepreneurs may be simply misguided or misled by adverse reports, associates, suppliers,
trade-unions, clients or accountants. This leads them to believing on entirely opposing views
pertaining to sustainability standards.
The above is not a complete list of what will drive, or discourage, an industry to go for
sustainability certificate. There are many more factors. But at the core of every
industry is a desire to grow. Every enterprise wishes to increase the size of its business
and profits. If sustainability standards have the potential to guarantee the growth to
the industries, in long or the short term, the industries are opening up to the standards
and adopting the same in their businesses. Some however remain indecisive due to a
variety of reasons.
Finance and investment is however the key in making these decisions. Larger companies
with unlimited resources and access to better financing options at their hand tend to adopt
sustainability standards more easily. Smaller companies, however, do not have that luxury,
despite their advantageous position in writing the growth story of the industry and the
nation. Recognizing if the growth is centered in the MSME sector, and voluntary
sustainability standards can maximize these potentials to the full, what role should financial
organizations (both international and domestic should play)? What type of financial
solutions should be developed for MSMEs? How financing and repayment be made easy
for MSMEs? Some of these answers we shall be exploring in our next section.
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10 Voluntary sustainability standards for MSMEs and demand for finance
A number of responses recorded for this study indicated that a substantial number of
MSMEs, especially those involved in export generated textiles and apparels business; adopt
sustainability standards using their own resources. Their direct investments are in terms of
fee for standard organizations and indirect in terms of infrastructural and methodological
investments. Where do they fund their sustainability needs from?
Some, as mentioned below, achieved sustainability, through internal resource allocation,
one-step-at-a-time, that took them a life time to reach the certification standards. A large
number, however, turned to banks loans and finance companies for their needs. A number
of them lose their competitive edge due to resulting price escalations commanded by higher
rates of interests billed to them.
Contrary to the belief that only larger players are interested in sustainability, a large number
of smaller businesses are also financing their sustainability investments. But, again, size
sometimes turns out to be their big adversary. As Rajesh Bheda puts it, “As there are
different sizes of enterprises in the supply chain, there are different sizes of buyers and
customers also, but their sustainability demands are more or less. A small players with a
small order of say 10,000 units carry the same responsibility as a large corporate with an
order of 100,000 units”.
Most MSMEs fail to invest in more sustainable processes due to lack of reliable partners
who could finance their investments. Very few options have been developed in the country
which could offer the MSMEs a revenue model that could transform their infrastructure at
a recoverable cost. Mainstream banks are always reluctant to fund such investments.
Moreover, even at a time when MSME loaning is a major banking activity, most mainstream
banks are lacking in sustainability specialized personnel and know-how that could help them
evaluate and understand MSME proposals for such demands.
Standards organizations, on the other hand are much better placed in funding their
international standards advocacy, policy and implementation regimes. Most of the donor
agencies focus on strengthening the standards organizations as a tool for dissemination of
their sustainable development goals. VSS promoters and organizations are supported
through grants in their various activities. MSMEs fail to obtain financial support from donor
organizations mainly due to prevailing rules under Foreign Contribution and Regulation Act
that bars profit making enterprises from receiving foreign donations.
While most donor agency efforts are focused on scaling-up the international standards
operators very few are actively thinking about investing directly with the MSMEs to
increase their access and implementation rate of the standards. On the contrary, however,
the standards organizations are raising revenues from MSMEs for their services in
certification processes. MSMEs on the other hand have also to pay to sustainability
consultants their hefty fees. Standards market is growing worldwide as about more than 500
VSS operator have set their base, many of whom have their offices and highly paid staff at
multiple locations. All this is adding to the costs incurred by the MSMEs.
In this context DISHA standards initiated by Apparel Export Promotion Council (AEPC) or
the EcoMark standards of the government of India are better placed in extending
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performance linked awards and incentives to MSMEs showing better environmental and
social impacts.
Under DISHA about 487 factories were enrolled by March 2014 in their sustainable human
capital advancement program funded by AEPC. However, the program was rolled back by
September 2015 as the AEPC decided not to use its funds for the program (vide letter No.
AEPC/HO/SG/ 2015 dated 29th September, 2015).
The ECOMARK, promoted by the Bureau of Indian Standards (the national standards
organization of India) however has a better supportsystem for the MSMEs. The marking
scheme was started in 1991. One of the purposes of the mark is to inform and guarantee the
consumers towards reducing environment impact. ECOMARK is operated by the Ministry
of Environment and Forest, and has a provision of incentives and rewards for
manufacturers and importers to reduce adverse environmental impact of the products.
However, EcoMark is not very helpful for Indian exporters to access the international
markets where consumers are more familiar with international marks.
Most common issue faced by the producers is that buyers demand high standards but always
pressurize for low prices. While MSMEs are expected to volunteer for sustainability
standards, buyers and consumers never volunteer to internalize the costs incurred on
standards. Buyers exert pressure to keep the prices low because, as “higher the cost of the
commodity, lesser there will be demand from the consumers”. Buyers also press producers
because of uniformity of taxes in most countries irrespective of size of exports and absence
of sustainability linked benefits in taxes.
Sustainability costs are not equally divided among all the participants of the value chain,
while the benefits of sustainability are reaped by all.
The standards organizations are playing a remarkable role in developing multi-stakeholder
partnerships that are crucial to supporting these initiatives. The challenges MSMEs face in
participating and benefitting from these partnerships again stem from lack of resources and
finances. All the services offered by sustainability organizations such as training and
capacity building, group certification, farm to factory alignment, etc. have transactional
costs involved that small organizations cannot afford.
While the manufacturing sector is still at some advantage, significant challenges are faced
by the primary sector producers, where social goal of empowering the poor is obstructed by
clashing grassroots realities, such as technocratic approaches or adverse traditional practices
(Lambin, 2014). Access to banking and access to markets are still big questions for
grassroots based MSMEs.
“Furthermore, the plethora of competing standards, along with the multiple agents
promoting and implementing them, can undermine the credibility of VSS and lead to
confusion amongst potential standard takers and financiers. Comply with multiple standards
also increases the transaction costs” (Knorringa, 2012). This presents a negative image to
the banks and finance companies.
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11 Avenues & challenges for sustainability funding for MSMEs
Micro and small enterprise need diverse services and support. A range of institutions need
to understand and specialize in serving their particular requirements. These include
commercial and development banks, finance companies, credit unions, co-operative banks,
thrift and saving societies, and other intermediaries. However, almost all these entities
widely follow fundamental principles of finance, where return on investments is a priority.
MSMEs often face obstacles in getting access to finance.
Banks and other financial institutions are often reluctant to fund such investments where
returns are not monetized. Social and environmental investments carry uncertainties and
higher risks. The high rates of interests prevailing in MSME loaning are another concern.
The best for MSMEs is Interest Subsidy Eligibility Certification Scheme (ISEC) of
Government of India implemented mainly through Small Industries Development Bank of
India (SIDBI). Under the ISEC scheme, small industries could avail a credit on concessional
rate of 4 per cent annual interest on capital as well as working expenditure, if they fall in
the non-profit industries category operating in khadi and village industry sectors.
Certain banks, especially those in private sector, have informally developed negative criteria
against loaning persons from certain professional backgrounds. Persons engaged in NGOs
and NGO led activities are among them. Since most VSS are operated by NGOs, banks may
be wary of funding standards led by them.
Moreover, most donor linked funds are not designed in ways that are consistent with best
international practices and long-run development of sustainability framework. On the flip
side, the crowding of VSSs is also a factor that is undermining their credibility and
importance as a viable investment option. A robust standard system should ideally
incorporate functions that are recognized by financial institutions; such as infrastructure and
organizational development of MSMEs. Growth is a major requirement of the MSMEs and
is common across the sectors, industries and among nations. Growth of MSME is
recognized as an important factor for global business growth. However, a majority of donors
supporting are stand-alone standards limited to fringe areas of sustainability and missing the
greater goal of growth; of local enterprise, of the value chain, of the global market.
Government subsidies have a higher potential for moving towards a better sustainability
regime for MSMEs. But government subsidies need to undergo a “radical overhaul” to
effectively deal with rising global sustainability concerns37. E.g. the highly subsidized skill
development initiatives that the government has undertaken in partnership with the
industries is targeted towards sustainable employment for the marginalized youth, however,
the sustainable employment is subjective given migration model many of these programs
follow and their crowded existence in un-sustainable slum clusters.
Considering the need for external support, creation of United Nations Sustainable
Development Goals Fund (UNSDGS), is a major international sustainability development
cooperation mechanism that recognizes the important role of MSMEs in sustainable
development. The Fund is aimed at connecting businesses, and creating avenues where they
37 UNEP Report
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could participate (with UN agencies, governments and civil society), in a collective pursuit
towards sustainable development goals.
According to Paloma Duran, head of UNSDG Fund, “Achieving sustainability – which
combines economic growth, social progress and environmental protection – requires us to
go the extra mile. Only when businesses are part of development programs can we achieve
this.” As MSMEs form the backbone of the business output and serve directly in the most
backward areas, these efforts must give priority to MSMEs in sustainability funding.
However, there are some fundamental challenges in this framework, these relate to lack of
UN infrastructure for engaging with MSMEs, dwindling funds of the UN system itself,
higher opportunity of partnering with the larger businesses. Collection of funds under
UNSDGF is also a big concern, given past failures in getting private funds for public good
(e.g. $100 billion fund for UNFCCC promised by various sources by 2020 has very little
collections).
One of the attractive ways of developing finance framework for micro, small, and medium
enterprises could be by supplying credit for micro-finance and rural finances. Many parts
of the country have well-developed micro-finance networks that can be a useful channel for
scaling up MSME finance for sustainable development. Microfinance is also an inclusive
way of involving the poor, women and other disadvantaged groups.
Ministry of Small Scale Industries in its memorandum dated 17th March 2014, observed that
total requirement of micro-credit in the countrywas $ 50000 billion. Micro-credit program
works through NGOs and local groups called SHGs. SIDBI’s micro credit program has a
high rate of recovery, 98%. But the combined reach of micro-credit program is very low.
Secondly, the high rates of interests prevailing in the micro-credit program may not be
suitable for MSMEs.
12 Conclusion
The Indian Micro, Small and Medium enterprises (MSMEs) have emerged as the ‘engine’
of economic growth. At a time when their contribution is well recognized for domestic
growth; their impact is also demonstrated on global growth, through their export potential.
MSME’s are also recognized as an important player in sustainability. They are credited with
generating high rates of employment and admirable capacity for innovativeness and
adaptability. MSMEs reduce regional imbalances by promoting industrialization of rural &
backward areas. They are an important vehicle for equitable distribution of incomes and
wealth.
With a wide penetration and reach, they are more inclusive and accessible as compared to
large industrial units. Their nearness to the primary producers places them better in
responsible consumption of natural resources. Factors like these, and several others, make
MSMEs strategically important to economic growth and socio-economic development of
the country.
The emergence of Voluntary Sustainable Standards (VSS) places both, advantages and
challenges for the MSMEs. On the one hand, MSMEs are encouraged to adopt the
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sustainability standards for better opportunities and remain in standards certified global
business chains. On the other hand, MSMEs are faced with challenges like how to finance
their sustainability needs or channelize their limited resources.
Among the examples of how better planning of available resources and innovation has
helped some MSMEs, their enormous struggles in financial, technological and strategic
challenges are also quite visible. Of the many challenges, the straight-jacketed approach of
the financial institutions is one that rides above all their business decisions.
With the changing development paradigm at international levels, international donor
organizations have started recognizing the importance of MSMEs in environmental and
social sustainability.
13 Recommendations
Voluntary sustainability standards epitomize the market-linked instrument that can facilitate
equitable development of micro, small and medium producers into global value chains. A
number of stakeholders have a defined role to enable this process by providing the necessary
supporting conditions. They can see themselves as agents of development given the socio-
economic impacts of MSMEs. As we have shown in this report, spread of awareness and
information, friendly policies, ease of access to resources and finances and capacity
enhancement are some of the key determinants underlying the promotion, integration and
success of VSS. Among other things, a supportive role of the government and international
donors is a vital element to foster effective framework for sustainable development.
International donors and governments of the day have an enormous task of facilitating an
environment for VSS in the MSME sector. There are many ways this could be achieved.
Donors can directly engage with standards organizations to develop more realistic and
comprehensive standards framework. They can directly work with MSME sectors in
awareness building, capacity, and cluster development programs.
Donors could also help in creating multi-stakeholder coalition comprising different
stakeholders to facilitate, monitor, evaluate, VSS in MSME sector. Donors can also provide
financial and technical support to MSMEs in their standard adoption needs, which will be
instrumental for a large number or organizations in the country. Donors can help set up
knowledge sharing platforms regarding VSS impacts, promoting observer groups providing
objective analysis of the effectiveness and impacts of the VSS and helping their replication
at the larger scale. Donors can also aid in developing learning and development platforms
for VSS implementers and adopters.
Apart from this, infrastructure is also an important area where investments and donor
interests can make a valuable contribution. Donors can help create investment platforms
that could undertake work on cluster level sustainability issues as well as issues faced by
individual MSMEs.
Besides the donors, government can also play an important role by adopting VSS in broader
policy framework. A public policy approach to VSS will be helpful in developing
sustainability linked schemes, programs and financial framework for banks and financial
Drivers and constraints for adopting sustainability standards in SMEs: an Indian case study (Part II: Micro)
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 91
institutions. There is a need to institutionalize the VSS and this could be achieved by
integrating public policy with international frameworks.
Standards adoption commonly has formal or informal transactional costs involved in
certification programs. Standards organizations can help internalizing or distributing this
cost either within the value chains or externally through easy financing options.
They can also help producers gain greater access to governmental and non-governmental
financing sources. In doing so, the standards organizations can extend the scope of VSS
beyond just the producers but also the financiers, donors and other interest groups in the
sustainable development paradigm.
Standards organizations can facilitate better access of MSMEs to technical assistance
needed in the compliance process. Availability of technical assistance in the areas such as
clean technology, innovations, resource replenishment, organizational transformation,
strategic management, will influence a large base of MSMEs as they are already inclined
and attracted towards these approaches.
Financial institutions and banks have the most crucial role in MSMEs decisions regarding
sustainability standards. While direct financial assistance to assist with VSS compliance is
necessary, sustainability linked revenue models and investment options could also be
developed. Financial institutions need to bring down the transactional costs by studying the
gaps between the pre-certification state of the products and the state necessary to obtain
certification. In order to close this gap substantial technical knowledge will be required that
the financial institutions will have to develop. This gap could be plugged by the donor
assistance to the financial institutions under sustainability initiatives.
Government’s contribution through effective policies has been very helpful for the growth
and development of the MSMEs. A more supportive, and sustainability linked, financial
framework, however, will be of great help to MSMEs adoption of sustainable practices. It
will help MSMEs leverage their competitive advantage more effectively and create a level-
playing field for MSMEs vis-à-vis their larger counterparts. More vigorously promoting
VSS will allow them to compete on fair and equal terms in the global value chains.
Emergence and better acceptance of MSMEs in the GVCs will help in creating a new
economic order where small businesses will play a big role in global business and
sustainability.
Shikhar Jain / Archith Ashok
92 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
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Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 93
V Drivers and constraints for adopting sustainability standards in
small and medium-sized enterprises (SMEs) and the demand for
finance: an Indonesian case study
Yose Rizal Damuri, Centre for Strategic and International Studies (CSIS) & Bagus
Santoso, DEFINIT
Background
With growth of Global Value Chain and economies become more integrated, it is important
for businesses to derive benefits from their participation in GVC. In GVCs, Multinational
Enterprises (MNEs) plays a leading role by coordinating networks activities of seller and
buyer. It also opens up a lot of opportunities to Small Medium Enterprises (SMEs) by
participating in the process, including those in Indonesia. However, since most SMEs are
more followers than leaders in this process, challenges in joining GVCs abound, including
from the requirement to follow certain standards. This paper takes a look at the issue of
challenges faced by Indonesian SMEs to be integrated into GVC, such as lack of efficiencies
(due to small-scale production), limited access to finance and hesitance to comply with
standards prevailing in the GVCs.
Sustainability standard are gaining considerable attention as public awareness
increases,especially on social and environmental issues. One of the objectives of
sustainability standards, in addition to ensure the quality of final product, is to attempt
covering or tracing the whole value chain process from producer to consumer. The purpose
is to run business responsibly, not only to society but also to the environment. There is a
growing importance for business sector, including SMEs, to implement sustainability
standards in their daily operations. Therefore, business entities in Indonesia must comply with
national regulations and standards, including several international standards that are adopted.
There are several sustainability standards currently in place in Indonesia, both the
international and national standards. Examples of the international standards are the general
standards such as those issued by International Standard Organizations (ISO), Roundtable
Sustainable Palm Oil (RSPO), Forest Stewardship Council (FSC) and Programme for the
Endorsement Forest Certification (PEFC), International Council on Metal and Mining.
Meanwhile, the national standards include Indonesia Sustainable Palm Oil (ISPO),
Indonesian Forestry Certification Cooperation Program (IFCC) that issues Timber Legality
Assurance System (Sistem Verifikasi Legalitas Kayu/SVLK). Furthermore, the financial
sector is currently encouraged to also create financial products and services through
sustainable finance program, which will be elaborated in Chapter 4 Section 4.
Nevertheless, adopting sustainability standards requires SMEs to change the way they run
their business since it has involves interaction of various activities along the supply chain
and various stakeholders needed to implement the sustainability standards. For the
sustainability standards to hold, the willingness and of all related stakeholders to uphold the
sustainability requirement is of fundamental importance. Implementing the standards could
therefore also have an impact on the efficiency and performance of the SMEs, since this
might require extra efforts and costs.
Yose Rizal Damuri / Bagus Santoso
94 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
This paper is organized into five sections. Following the background, we would discuss
different types of standard, which can be categorized at least into two things (the setters and
the characteristics). This is followed by an overview (including value chain, total production,
and contribution to national economy) of coffee and textile (our two selected industries)
industry in Indonesia. This chapter will also contain results from in-depth interviews to SMEs
in the two selected industries to elaborate the main obstacles of SMEs for joining GVC
including, limited access to finance and government regulations. Chapter 4 will lay out
financing options for SMEs in order to adapt sustainability standards to join global production
network. The last section summarizes the findings based on our literature review and in-
depth interview.
1 Sustainability standards and certifications in Indonesia
1.1 Indonesian standards
Government Regulation No 102/2000 on National Standardization appointed the National
Standardizationcountries of GVCs, in turn, benefit from the spread of technologies
and knowledge, growing productivity and the subsequent effects on wages and income.
Instead of building own national industries over decades, local firms can specialise in
specific production steps, integrate into GVCs, and gradually upgrade to higher-value
activities (Marín-Odio, 2014; OECD et al., 2014).
Small and medium-sized enterprises constitute the backbone of every economy and account
for about 90 per cent of businesses and more than half of employment worldwide (IFC,
2013). Their importance is even more profound in developing and emerging countries.
Thus, growing participation of such countries in global production processes is necessarily
associated with integration of SMEs into supply chains and GVCs.
Due to their flexibility and ability to move fast, SMEs occupy niches for the supply of
products and services within global value chains (OECD, 2008). They usually provide
intermediates to larger exporting companies in their country and are thus part of the wider
supply chains of GVCs (Cusolito, Safadi, & Taglioni, 2016). Whether SMEs succeed in
Drivers and constraints for adopting sustainability standards in SMEs: introductory chapter
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 5
integrating into global production processes depends both on internal factors such as
managerial and workforce skills, innovation, technology adoption, knowledge absorption
and their ability to comply with international standards as well as external factors, that are
determined by the national economic and political environment; these external factors
include most importantly trade policy, ICT inclusion, infrastructure and logistic services,
access to finance, secure and reliable political, legal and social environments, enhanced
intellectual property protection, and geographical or cultural proximity to the sourcing firm
and/or export markets (Cusolito et al., 2016; Marín-Odio, 2014).
The spread of complex and intransparent production processes has stirred criticism about
abuses in GVCs. Suppliers, subcontracted firms, and other GVC participants are blamed for
routines of forced overtime, child labour, unsafe workplaces often with direct exposure to
toxic substances, and the reckless pollution of rivers, ground water and soil. On the one
hand, such criticism underlines the need and importance of sustainability standards and, on
the other, indicates how civil society organisations, the media, and conscious consumers
successfully mobilise public opinion to increasingly hold multinational corporations
accountable for deficiencies in GVCs and supply chains.
Sustainability standards first took hold in environmental resource- and labour-intensive
sectors, especially in those integrated into global production such as petro-chemicals,
mining, agriculture, forestry, chemicals, textiles, carpets, clothing and footwear industries.
From there, sustainability standards spread to GVC activities in industries and sectors where
consumers take ethical, social and environmental factors into account in their consumption
decision (Nadvi & Wältring, 2004).
Before the introduction of sustainability standards, civil society organisations called upon
consumers to boycott firms that disrespected labour rights and sustainable production (Potts
et al., 2014). Throughout the 1990s, for instance, Nike as a leader in sportswear was
consistently criticised for child labour and sweatshops in its supply chains and for not taking
responsibility for the malpractices of its suppliers and subcontracted firms. As a reaction to
these civil society actions, Nike has overhauled its codes of conduct and improved the
openness and transparency of its supply chains by publishing third-party audit reports
showing the compliance of suppliers with Nike’s sustainability principles (Birch, 2012).
More recently, an American newspaper exposed that cobalt mines in the Democratic
Republic of Congo relied on child labour and polluted rivers. As a consequence, Apple
declared that it would discontinue the business relationship with artisanal Congolese mines
until compliance with Apple’s standards was verified (Frankel, 2017).
These two examples show how conscious consumers, civil society, and the media can rally
public opinion behind reforms in supply chains. Moreover, such concerns are taken
seriously as a survey by PWC (2014) underlines: more than 91 per cent of CEOs agree that
the integrity of the supply chain is crucial for their firm. According to a survey by McKinsey
& Company (2014), the share of CEOs who picked sustainability as their priority has
doubled since 2012 and more than a third lists sustainability among the top three items on
their agenda. Interestingly, the motivation behind the concern for sustainability is no longer
driven by reputational risk (36 per cent) and cost reductions (26 per cent) alone, but rather
the majority of CEOs (46 per cent) seek to align sustainability with the overall business
goals, missions, or values. Apparently, CEOs are beginning to understand that sustainability
Christoph Sommer
6 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
is simply good for business. Khan, Serafeim, and Yoon (2016) show that firms with high
material sustainability investment get the best returns on their stocks even after controlling
for firm characteristics.
The spread of standards goes hand in hand with standard proliferation. For voluntary
sustainability standards, for example, the International Trade Centre (ITC) recorded about
50 different standards in 1997, while 20 years later the number has risen to over 200 (ITC
& EUI [European University Institute], 2016). The Ecolabel Index (2017) even counts more
than 450 sustainability labels. Firms seeking to adopt sustainability standards find it hard to
navigate through this increasingly crowded and complex standard landscape. As standards
often cover the same commodities or similar issues, overlap and competition for market
shares are unavoidable, so that standard organisations reject mutual recognition and avoid
interoperability of standards (UNFSS [United Nations Forum on Sustainability Standards],
2016). The lack of interoperability may require firms that sell to various buyers which have
a preference for different standards to adopt all these standards simultaneously. The obvious
response to this unfavourable situation, which threatens the operability and relevance of
VSS, is harmonisation of similar standards under the guidance of intergovernmental
organisations, governments, donors, and meta-standard organisations. Yet progress is slow
and cannot keep pace with the mushrooming of new standards (UNFSS, 2016). The debate
around proliferation and harmonisation of standards is not peculiar to VSS, but is also well
established in literature for all types of standards – examples are standards in trade (such as
Disdier, Fontagné, & Cadot, 2014); green finance (such as Berensmann, 2017); and others.
One source of standards proliferation the localisation of standards adds another level of
complexity to the harmonisation discussion. Local non-governmental organisations (NGOs)
and national governments may launch new standards initiatives that adjust requirements to
national realities. While this improves the applicability and adoption of standards, it
aggravates the proliferation problem. Localisation of standards is especially attractive in the
context of developing and emerging economies because the requirements of international
standards are often perceived as inapplicable to the local climatic, societal, and economic
environment or as too demanding or exclusionary. Less stringent local standards may foster
the spread of social and environmental standards and thus advanceAgency (BSN) as the institution to oversee the implementation of national
standard in Indonesia. According to the regulation, the obtainment of SNI is voluntary for
most of the goods. While for some other goods considered to have direct safety concern
among others, obtaining SNI is mandatory.
There are three main institutions responsible for developing and overseeing standards in
Indonesia. Badan Standardisasi Nasional (BSN) or the National Standardization Agency of
Indonesia is the government institution in charge of coordinating and facilitating
standardization activities. There are three standards & conformity measures that need to be
conducted on the national level, (i) regional standards adoption, (ii) transposition of national
technical regulations, and (iii) conformity assessment procedures. BSN is the lead agency
appointed by the government for conducting these measures, especially for measures (i) and
(iii). Along with BSN, there are also Badan Nasional Sertifikasi Profesi (BNSP) which
maintains competency standards for Indonesian workers, and also Badan Standar Nasional
Pendidikan (BSNP) that oversees the nation’s education standards.
Meanwhile, all technical regulations are under the authority of relevant technical authorities.
This means different ministries/institutions will become the technical regulatory authorities
for different types of products. Mandatory SNI is enacted by the issuance of several Ministry
of Industry Regulations on specific type of goods.In automotive sector for example,
Mandatory SNI covers goods such as alloy wheels, tyres, and laminated glass, along with
some other automotive components.
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 95
Table 1: Technical regulatory authorities in Indonesia
Name of Ministries Products under authority
Ministry of Industry Food & beverages industry, forest & plantation products (IHHP), furniture,
automotive, machines, textiles, paint, etc.
Ministry of Maritime Affairs &
Fisheries
Fisheries products & processes
Ministry of Trade Label registration Import, and export
Ministry of Agriculture Fresh food, plant origin, livestock, food of animal origin
Ministry of Transportation Vehicles
National Agency of Drug and
Food Control (BPOM)
Processed food, contaminant, additives, food label, drug & cosmetics
Ministry of Manpower Profession
Ministry of Forestry Raw materials from forest and timber plantation, sawn timber and plywood
Ministry of Environment Waste water, air emission waste, hazardous waste
Source: DFC S.A.U. Study (2011)
Indonesian National Standards (SNIs) are ruled to be voluntary according to the new Law
on Standardization. However, they may be mandatory for products related to national
security requirements, the protection of human health or safety, animal or plant life or
health, and the environment. As of 2014, the number of SNIs already developed had reached
9,888 standards, of which 270 are mandatory for all products distributed in Indonesia, both
local and imported. These standards are broadly distributed across sectors, with material
technology and agriculture and food technology contributing the most, at 23% and 16%
respectively. Of 270 mandatory standards, the majority of them are regulated by Ministry
of Industry (36%) and Ministry of Maritime Affairs and Fisheries (30%).
In regulatory making process, SNI is also affected by elements in sustainability standard.
Since the 1980s, NGOs and the global private sector have begun to apply standards that
were initially voluntary to regulate the production of goods and services in a global
production network. The main objective is to improve sustainability through safer,
environmentally friendly and more efficient production practices in various industries.
Sustainability standards are applied ranging from commitments to evade child labor to
restrictions on the use of pesticides and chemical fertilizers.
Yose Rizal Damuri / Bagus Santoso
96 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Figure 1: The process of SNI certification
Source: Industry Certification Agency (2016) and modified by author
At least, we can distinguish standards into three categories, such as major actors that are
involved in setting the standard, nature of the standard (assessing in process product or final
product), and geographical areas of standard (international vs local).
1.2 Sustainability standards in Indonesia
Majority current sustainability standards and certifications in global production networks
come from initiatives of non-governmental organizations, development agencies and the
global private sector. Most of these are in the agricultural sector where around 40% of the
world's coffee production is certified and 15-20% of cocoa and tea production also adheres
to international sustainability standards. In addition, other sectors are forestry, wild
fisheries, cotton and palm oil are also starting to practice certified sustainable production.
In Indonesia, there are some adoption to these sustainability standards, described in the
following Table 2.
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 97
Table 2: Examples of sustainability standards in Indonesia
Type of standards Name of standard /
regulation
Elements
Private standard Toyota Production
System (TPS)
Mandatory for Toyota’s suppliers. Maintaining quality
until final products by using technical and management
practices. This is also called “Leaning manufacturing
system” to reduce lead time, to obtain best quality at
lowest cost.
Starbucks Coffee and
Farmer Equity (CAFE)
Mandatory for Starbucks’ suppliers. Set of
sustainability standards that focuses on quality,
economic accountability and transparency, social
responsibility, and environmental leadership. Using
third-party verification body: SCS Global Services.
Government
standard
Environmental Standard
(Law No 32/2009)
Mandatory. To measure the important of environmental
impact on business, and managing and monitoring
further located in Indonesia.
Labor Standard (Law
No 13/2003)
Mandatory. Prohibiting child labor with the exemption
for 13-15 years of ages: have the permission from their
parents, maximum 3 working hours, do not interfere
their school time.
Indonesian National
Standard (SNI)
Mandatory for some specific product or condition.
Timber Verification and
Legality System
(SVLK)
Mandatory. To reduce illegal logging. To ensure
legality of materials being export and to support
traceability.
Indonesian Sustainable
Palm Oil (ISPO)
Mandatory. Ensuring sustainability to reduce
greenhouse emission using several principles such as
guidelines for cultivation and processing, environmental
management, and social responsibility.
Civil society
standard
Utz Certification Voluntary. Code of conduct for growing sustainable
coffee based on ‘good agricultural practices’ that
include standard on environmental protection and
management, and labor & living conditions.
Bird Friendly Coffee Voluntary. Minimum standard for vegetation (diversity)
and standard for soil management, also cover 100%
organic and shade grown
Fairtrade Voluntary. Minimum guaranteed price paid to
registered small farmers’ organizations that match socio-
economic standard development, labor issues, and
environmental protection.
OEKO Tex Voluntary. Certify firm in the context of chemical &
environmental management, occupational health &
safety, social responsibility, quality management, and
transparency
Source: Author’sconstruction from many sources, Ponte (2002) and Giovannuci (2005)
Yose Rizal Damuri / Bagus Santoso
98 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
1.3 International vs local standard
In regards of geographical impact point of view, we can distinguish sustainability standards
into two categories, international and local standard. The nature ofInternational standard,
even though are globally accepted, it usually non-mandatory. Nonetheless, complying with
international standard could increase the opportunity for firm joining global value chain.
One of the example of international standard is ISO 22000 concerning food safety.
Meanwhile, local standard or standards that have been set by government are mandatory in
nature. Despite the existing of international standard, adjustment needs to be done (as a form
of local regulations) due to difference environmental condition in each country. One of
Indonesian standard related to food safety is regulated in Head of BPOM Regulation No
11/2014. For food containing Genetically Modified Organism (GMO) is regulated under
different regulation, Head of BPOM Regulation No 1563/2012.
Another example in this type of standard is in palm oil industry. Roundtable on Sustainable
Palm Oil (RSPO) is a group that unites stakeholders from 7 of palm oil industry; producers,
processors, consumers, retailers, banks/investors, and NGOs. It aims to create guidelines
for Certified Sustainable Palm Oil (CSPO) to help minimizing negative impact of palm oil
cultivation on environment. There are 8 principles that must be accomplished by firm in
order to be certified, which are; (1) commitment to transparency, (2) compliance with
applicable laws, (3) commitment to long-term financial viability, (4) use of appropriate best
practice by growers and millers, (5) environmental responsibility and conservation of
natural resources, (6) responsible consideration of employees, (7) responsible development
of new plantings, and (8) commitment for improvement in key areas of activity. In addition,
verification and audit must be conducted every 5 years by third-party RSPO-accredited
certification body.
In Indonesia, Indonesian Sustainable Palm Oil (ISPO) is a mandatory national standard to
improve sustainability and competitiveness in Indonesia’s palm oil industry and contribute
to reduce greenhouse emission.The standard is mandatory for all oil palm growers in
Indonesia, including the smallholder. However, for large producers were required to comply
with the standard in 2014, while Ministry of Agriculture has set a target for smallholders in
2022. ISPO is part of Sustainable Palm Oil initiatives, developed with a support of United
Nations Development Program (UNDP). The principles that have been set in ISPO such as;
(1) licensing system and plantation management, (2) technical guidelines for palm oil
cultivation and processing, (3) environmental management and monitoring, (4)
responsibilities for workers, (5) social and community responsibility, (6) strengthening
community economic activities, and (7) sustainable business development.
Regarding of these two standards, there are some distinctions which we can elaborate more.
While ISPO is much more practical to implement, it has fewer criteria than RSPO. In terms
of business practices and commitment to transparency, RSPO is much more transparent in
its standard development and auditing results relatively to ISPO (Efeca, 2015). In regards
of social impact, ISPO that relies on AMDAL process social impact assessment does not
provide extensive requirements for management system. As to social issues, RSPO much
more advance with clear and detail guidance on worker rights and health and safety, while
ISPO only stated that worker must be enrolled in government’s social security program.
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 99
Box 1. ISPO vs RSPO
Although ISPO has a very well objectives, to ensure every businesses in palm oil industry comply on
environmental standard, but it creates another hurdle for firms. Since the nature of ISPO is mandatory, it
makes every palm oil growers operated in Indonesia have comply with the certification. However, this
certification has not been well accepted by international related parties due to several distinctions in terms
of guidelines and requirements with international standard which is RSPO. This condition complicates
firms who want to export their products abroad, causing them to comply with two standards which are very
costly and time consuming.
In February 2016, a report of joint study between Indonesian government, Sustainable Palm Oil Initiative
(SPOI) (which is established by several multinational companies to address some systemic barriers in palm
oil industry), and United Nations Development Programme (UNDP) has been released concerning the
similarities and differences of certification system of ISPO and RSPO. The purpose of this study is to create
better alignment between ISPO and RSPO and also to reduce costs, time, and complexity to comply with.
Moreover, by analyzing the similarities and differences of two system, this study provide recommendation
for more efficient field audit by integrating same requirements into one single audit, while different
requirements will be separately inspected.
In this study, at least there are several points that could be highlighted to discuss further. In regards of new
plantation, ISPO requires firms to provide certification for plantation that have legally approved land
(including HGU license) following new indicative government plantation postponement map. While RSPO,
does not allow new plantings on converted primary forest, HCV and High Carbon Stock (HCS) and areas
that developer has not obtained FPIC of indigenous and local peoples. This means, both certification only
give certification for legally approved land and firms have comply with national and district regulations.
This can be used as a basis to conduct combined audit.
Several distinctions of these two certifications which are highlighted in the report such as the independent
third party certification body. ISPO and RSPO accreditation bodies Indonesia need to be accredited by
National Accreditation Committee (KAN). But since 2012, RSPO accreditation bodies also need to be
accredited by Accreditation Services International (ASI). In the assessment process, RSPO categorizes as
minor major indicators, whereas all indicators in ISPO are major and compulsory.
1.4 Product vs process standard
Product standards address final output or final product as a result of production process. The
characteristics of this standard often unambiguous and are defined by quality requirements.
In this kind of standard, standard setters are usually seeking to increase the quality of final
product and reduce cost. For example, in case of standard set by third-party, standard for
exportable Arabica coffee by ICO is 86 defects out of 300 grams, with the moisture content
below 8%. The minimum levels of permitted defects may drive firm to produce more
effectively and would reduce cost of production. Meanwhile process standard, usually are
more complex and tricky due to involving documentation procedures in every stage of
production to fulfill traceability component. One of the example of process standard is Bird
Friendly Coffee certification. In Indonesian Standard (SNI), in order for a firm to obtain SNI
certificate, they should comply with final product standard (which will be assessment in lab
verification) and process standard (which will be audited by LSSM in order to look at quality
system). The reason why SNI certification also needs quality management system is to ensure
firm couldproduce similar and standardize quality of goods in some period of time.
Yose Rizal Damuri / Bagus Santoso
100 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
1.5 Sectoral cases: standards in coffee and garment sector
There are several sustainability standards in coffee and textile industry which created by
civil society and also applies for Indonesian firm. One of the example of third-party standard
is Fair Trade, which aims to improve the livelihood and welfare of small producer by paying
a fair price with a fixed minimum and continuity in trading relationship (Giovannucci &
Koekkoek, 2003). The impact of Fair Trade in producing countries is generate income of
producers, capacity building, organizational skills, and resilience to external shocks
(Muradian & Pelupessy, 2005). Another standard that has been set by civil society is Utz
Certification (or was known as Utz Kapeh). This standard originally was created by Ahold
Coffee Company (private sector standard), and is now an independent foundation that has
developed code of conduct for growing sustainable coffee (Giovannucci & Ponte, 2005). It
serves minimum assurance that basic condition met and less strict than SMBC bird friendly.
Meanwhile, Bird friendly coffee or shade-grown coffee certification has created system for
production, processing, and marketing of shade grown organic coffee. This standard is
known as the most rigorous certification scheme due to combining technical requirement
quality with shade cover and species richness (Muradian & Pelupessy, 2005; Giovannucci
& Ponte, 2005).
Besides civil society standard, private sector standard is also existing in coffee industry.
Starbucks, with its program called Coffee and Farmer Equity (CAFE), which are part of
Starbucks’ preferred supplier program establishes set of sustainability standards that focuses
more on quality, economic accountability and transparency, social responsibility, and
environmental leadership. The aim of CAFE practices is to create a long-term supply of
high quality coffee and positively impact the lives of livelihood of coffee farmers and their
communities.
Meanwhile in textile industry, Sustainable Textile Production (STeP) as a civil society also
created sustainability standard called OEKO Tex 100 and OEKO Tex 1000 standard. The
standard requires firms to optimize energy consumption through energy recovery practices
and restrict some chemical substances to be used as materials in textile production process.
Workers health and safety have also become important elements in this standard, which
encourage firms to provide equipment for handling some hazardous materials and prevent
workspace from harmful dust and noise stress.
2 Analysis of the incentives and challenges for SMEs to adopt sustainability
standards
This chapter will discuss two main aspects related to the adoption of sustainability standards
by Indonesian SMEs. First part will analyze incentives and potential drivers for Indonesian
SMEs to adopt sustainability standards as well as stakeholders that promote the spread of
standards. The second part will discuss challenges for SMEs to adopt the sustainability
standards.
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 101
2.1 Incentives and potential drivers for Indonesian SMEs to adopt sustainability
standards
The drivers for adoption of sustainability stadards in Indonesia can come from two directions.
One factor is market driven incentives, including higher prices and greater access to market.
Another incentive comes from government programs that provide incentives toward the
adoption of social and environmental actions. Among those initiatives are the GoI’s Economic
Policy Package (Paket Kebijakan Ekonomi/PKE), the development of Master Plan of National
Industry Development (Rencana Induk Pembangunan Industri Nasional/RIPIN), the
implementation of Rating Program for Business Performance in Environmental Management
(Program Penilaian Peringkat Kinerja Perusahaan/PROPER), Cleaner Production (CP)
program, tax policy, government awards, Emission Reduction Investment (ERI), and
investment policies.
2.1.1 Market incentives for the adoption of sustainability standards
Natural drivers or incentives from market are needed in order for firms to adopt
sustainability standards. These incentives from market usuallally are benefitted directly for
producers. At least, there are several potential drivers by the market that can encourage
Indonesian firms to obtain sustainability standards such as, higher selling price, having a
wider market, and long-term production.
The first incentive for businesses to adopt sustainability standards is higher selling price.
International buyers which concern about sustainability issue often offer higher prices for
those products that are compliance to sustainability standards. In the case of coffee industry
in Indonesia, prices of green beans from growers that comply with sustainability principles
are quite different from those who do not. Although growers (coffee farmers) need to adapt
those good farming practices, which often costly and burdensome for them, they can expect
additionalrevenuefrom higher green beans price. Several certification,such as Fair Trade,
explicitlydetermine higher selling price for those products.
Another incentive that can be obtained by businesses for complying sustainability standards
is the possibility of having much wider market. International buyers in developed countries,
especially from European countries and US, are paying high attention on sustainability
issues and using it as a standard compliance in their requirements when they look for firms
to be put into their value chain production. This condition is an overview of global
production network in textile industry. Thus, complying with sustainability standards is one
of the tools to enter advanced market countries.
Kadarusman (2010) in his study ilustrated buyers in advanced market, including big brand
names, impose standards and social and environmental compliances to Indonesian garment
industry as basic requirement to join their production network. Many of them have their own
code of conducts or require the adoption of certain certification in the production. This is
different than developing countries market such as Middle East or African countries which do
not strictly regulate the compliance. Meanwhile in coffee industry, complying sustainability
standards mean businesses are entering higher market with higher selling price. A niche
market of specialty coffee, for instance, can offer the price up to two times higher than regular
Yose Rizal Damuri / Bagus Santoso
102 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
coffee; and complying with sustainability standards is the basic requirement for this type of
coffee.
The implementation of sustainability standards on business also potentially affect long-term
production. In coffee industry for example, by implementing sustainability principles to
achieve good agricultural practices such as knowing the right way of picking technique, not
using chemical substances, and others could spur the growth of coffee plants in the next
harvesting period. In fact, the right way of picking could ensure plants to re-grow without
any assistance.38 The know-how of planting and harvesting in coffee plantation is very
important for the businesses or land owners to ensure sustainability in their business
2.1.2 Master plan of national industry development/Rencana Induk Pembangunan
Industri Nasional (RIPIN)
GoI has issued Government Regulation No. 14 Year 2015 concerning a Master Plan of
National Industry Development/Rencana Induk PembangunanIndustri Nasional (RIPIN)
Year 2015–2035. The strategies laid out in RIPIN include the development of green industry
and provide affirmative action in designing policies, strengthening the institutional capacity,
and providing facilities for small and medium industries. Green industry means embed green
concept as a series of green activities starting from the use of raw materials (clear origin),
production processes which apply the concept of 3R (reduce, reuse and recycle), as well as
control and waste management during and after use the resulting products.
The development of green industry consists of two main strategies, i.e. green industry
standardization and the provision of facilities for green industry. The strategic outcomes
emphasize innovation and technology capability that is energy-saving and environmentally
friendly. This is in line with Green Growth strategy as stated in Manila Declaration on Green
Industry (2009) that Indonesia already ratified. The strategy is translated to Green Industry
concept that includes Cleaner Production, 3R (Reduce – Reuse – Recycle), and Low
Carbon/CO2 Emission Reduction (Klarer, Berndt, & Sumaryana, 2013).
2.1.3 Rating program for business performance in environmental management/
Program Penilaian Peringkat Kinerja Perusahaan (PROPER)
In 1993, Indonesian Ministry of Environment introduced a public environmental performance
rating system, called PROPER. The rating program aims to promote industrial compliance
with pollution control regulations, to facilitate and enforce the practices of “clean
technology”, and to make sure a better environmental management system (Torres &
Kanungo, 2003). PROPER rating system uses colour identification. Each colour represents
how well a company’s environmental management practices. The colour rating system can be
seen in Figure 2:
38 based on writers’ interview with one of the coffee shop chain owner in Jakarta
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 103
Figure 2: PROPER colour rating system
Source: Ministry of Environment (2015)
In addition, based on Bank Indonesia Regulation No. 14/15/PBI/2012 and Letter (Surat
Edaran Bank Indonesia/SEBI) 7/3/DPNP issued in 2005, as a part of assessment of debtors’
business prospects, they encouraged banks to take into consideration “efforts undertaken by
the debtor in the framework of environment conservation”, for instance by using PROPER
Rating by the Ministry of Environment. However, the participants of the program were
mostly large scale industries, such as PT Pertamina, PT Holchim Indonesia, Chevron
Geothermal Salak, Ltd, and other big companies.
PROPER has been started since 2002. However, none of the company could get the gold
rating before 2010. According to a Ministry of Environment report (2015), out of 2,137
companies that were evaluated in the 2014-2015 PROPER program, 12 companies (1%)
were assessed as gold, 108 companies (5%) were assessed as green, 1406 companies (68%)
were assesse#d as blue, 529 companies (25%) were assessed as red, 21 companies (1%)
were assessed as black (see Figure 3).
Figure 3: The trends of PROPER compliance 2002-2015
Source: Ministry of Environment (2015)
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104 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Cleaner Production (CP) Program
In order to encourage stakeholders to implement the 3R (Reduce, Reuse, Recycle)
principles, Cleaner Production (CP) was initiated by GoI and has been developed since 1993
by Indonesia’s Environmental Impact Management Agency/Badan Pengendalian Dampak
Lingkungan (BAPEDAL), which currently named as Ministry of Environment. In 2004, GoI
introduced Indonesian Cleaner Production Center-ICPC (Pusat Produksi Bersih
Nasional/PPBN) to promote, facilitate, and catalyze, cleaner production through service
providers (AECEN, ICEL, & State Ministry of Environment of Indonesia, 2008).
In 2014, ICPC have a new role as an executor of resources pool management in serving the
application of Sustainable Consumption and Production (SCP) in Indonesia (Ministry of
Environment, 2014). SCP is program that aims to create patterns of economic production
that is more efficient. In 2013, SCP was launched as the 10-Year Framework of National
Programs and has been formally adopted in the 2015-2019 medium-term development plan
(RPJMN). The program comprises of (GGGI Green Growth Program, 2015):
1. The Ministry of Energy developing criteria for eco-labeling, systems to verify labeling
and public information to support this initiative, as well as green public procurement
2. The Ministry of Industry working towards green industry
3. The Ministry of Public Works and the Green Building Council developing green building
construction
4. The Ministry of Tourism building capacity for ecotourism based on sustainable
consumption and production models
Other example that applies clean production is rattan production called “Promoting
sustainable production and consumption eco-friendly rattan products” (PROSPECT)
program. This program has been initiated by PUPUK (The Association for Advancement of
Small Business), AMKRI (Indonesia Rattan Furniture Association) and in cooperation with
SNV (Netherlands Development Organization) and Innovations Zentrum Lichtenfels e.V.,
Germany which aims to support the development of rattan industry in Indonesia. This
program has been running since 2013 and aims to create Indonesian rattan products brand
that are environmentally friendly (Aldila, 2016). In 2015, PROSPECT has trained 1,200
rattan SMEs in Cleaner Production, published and distributed guideline books on rattan
cleaner production, and provided technical assistance to rattan SMEs in order to be able to
produce eco-friendly rattan products (PROSPECT Indonesia, 2015).
2.1.4 Tax policy
Since 1997, the Ministry of Environment in cooperation with the Directorate General of
Customs and Excise at the Ministry of Finance has given an exemption or reduction of
duties for imports on pollution control equipment and materials used by
manufacturing industries. This exemption is under Finance Minister Regulation No.
101/PMK.04/2007 concerning The Exemption of Duty on Equipments and Materials Used
in Environmental Pollution Control, which replaced Finance Minister Decree no.
136/KMK.05/1997. The equipment includes installations, machine and machinery and its
equipment and spare parts that are solely used for waste processing. The aim of tax
exemption is to facilitate industry that produces waste and waste treatment company to
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 105
provide more affordable equipment for environmental protection. In addition, zero import
duty is to encourage/motivate industry toward environmental protection.
In addition, government also offers incentives such as tax reduction on the cost of waste
treatment. In 2008, government issued Law No. 36/2008 on Fourth Amendment to Law
No.7/1983 on Income Tax. Based on the law, one of the costs components that could be
deductible from gross income is waste treatment cost. This regulation is stipulated in article
6 paragraph 1.
2.1.5 Government award
There are numerousaward related to sustainability standard initiated by government.
However, there were only limited award that targeted to SMEs. One of the examples of award
for SMEs is GreenIndustry Award.This award is initiated by Ministry of Industry in 2010
and applies to all size of business firm with different assessment. However, the number of
SMEs that participates the award were still minimum. In 2016, the number of participants of
Green Industry Award was 142 companies which include 127 large industrial enterprises, 14
companies of medium-sized industries and 1 company of small businesses (Maskur, 2016).
2.1.6 Emission Reduction Investment (ERI)
ERI is a program that has been developing by Ministry of Environment to support GoI’s 26
percent CO2 emission reduction target by 2020. The purpose of ERI is to finance industry’s
(including SMEs) environmental programs in order to reduce the emission. Like the DNS
program, ERI also gives low interest loan. Similar to DNS, ERI also offered by the German
Development Credit Bank/Kreditanstalt für Wiederaufbau (KfW) with total amount EUR
16.5 million loans. The program offers a loan period of 40 year with a period of 10 yr. The
interest rate of KfW to the Government of Indonesia was 0.75 percent per year with a
commitment fee of 0.25 percent per year.
According Ministy of Finance report (2014), the program offer two types of loans, i) Loans
up to Rp750 million for small-scale ERI investments; ii) loans up to Rp10 billion ERI
Investment for medium-scale enterprises. ERI program is expected to reduce the emission
up to 750,000 tones CO2 emission per year. The following are terms and conditions that are
applied to ERI program (Klarer et al., 2013):
a. Loan from KfW for the ERI program reaches 100 million EUR, with assumption that
an average loan size to industry is 10 billion IDR (708,546 EUR) and total projects
funded would reach 50 to 100 projects.
b. Eligible recipients of the loans are SMEs and larger firms including state-own
enterprises (BUMN) with capital in the range of USD 500,000 (470,543 EUR) – USD
5,000,000 (4,705,503 EUR).
c. ERI can be combined with commercial loans or other credit programs.
d. The amount of loan is up to 50 billion IDR (3.5 million EUR) and can also be disbursed
in dollars.
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106 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
2.1.7 Investment policies
Incentives are need to attract investor companies to not only invest but also linkage with
local/domestic actors, especially SMEs. Through the linkage, investor companies are
expected to share knowledge and technology so that the SMEs can be more productive and
be better suppliers. By being better suppliers, the SMEs more easily affiliate themselves
into GVCs. In this case, GoI’s investment policies can play a big role. The Indonesia
Investment Coordinating Board/Badan Koordinasi Penanaman Modal (BKPM) is a
government agency that is mandated to boost domestic and foreign direct investment
through creating conducive investment climate.
According to the World Bank survey in 2017, Indonesia ranked 91st which was increase 15
points compared to the last year survey39. Although there is an improvement, doing business
in Indonesia is still relative complicated and costly due to the illegal fees that businesspeople
have to pay in order to receive necessary documents. Ease of doing business is important
for SMEs, due to most of them are in the informal sector and do not have a license. The two
main problems that hinder businesses to register a business are: 1) the number of permits
that must be taken care of, and 2) high levels of corruption and inefficiency.
GoI’s efforts to promote investment in Indonesia can be seen in its economic policy
packages, particularly in the second, third, fifth, seventh, 10th, 11th and 13th packages that
include efforts to increase investment with easier regulations for business licensing to
simplify and improve the business climate for the industrial sector, for SMEs and for other
business sectors (Carolina, 2016). The following are some strategies and services by GoI
(through BKPM) in order to create a more conducive investment climate (BKPM, 2016).
1. Improving investment licensing services
a. One Stop Services (OSS) for Investment and 3-hour investment licensing
GoI established One Stop Integrated Services for Investment (OSSI) at national,
provincial and regency/city levels through Presidential Regulation No. 27 Year 2009
on OSSI and also its implementation regulations through 4 BKPM Chairman’s
Regulations No. 11, 12, 13 Year 2009 and No. 7 Year 2010 on Amendment to No.
14 Year 2009. All OSSI across Indonesia will be equipped with integrated computer
online system (National Single Window for Investment/NSWI) in order to make
easier investment services needed by investor/business entities. This online system is
centred at BKPM in Jakarta. Through OSS, investors can submit and obtain permits
exclusively at BKPM with time certainty and online monitoring.
In 2015, BKPM launched three-hour permit service. This program is based on
Presidential Regulation No. 4 Year 2015. The permit require that investments worth
more than Rp100 billion (US$6.79 million) or projects that could employ more than
1,000 local workers in industrial estates should be able to process their preliminary
permits at the BKPM’s OSSI in just three hours. The documents that are provided
consist of Investment License, Certificate of Incorporation, Tax Registration,
39 http://www.doingbusiness.org/data/exploreeconomies/indonesia
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 107
Company Registration, Import Identification, Customs Registration, Employment
Plan, Working Permit, Letter of Land Availability.
In 2016, areas that have been formed the OSSI consists of 34 provinces, 385 districts,
98 cities, 5 Free Trade Zone and Free Port (Kawasan Perdagangan Bebas Pelabuhan
Bebas - KPBPB), and 4 Special Economic Zome (Kawasan Ekonomi Khusus - KEK).
Then the areas that do not form the OSSI comprise 31 districts and 4 KEK. As a
result, at second quarter of 2016, investment realization has reached Rp151.6 trillion
or increase 12.3% compared to last year. This figure is the highest record of
investment realization in Indonesia. The source of this investments consist of
domestic direct investment amounting to Rp52.2 trillion (up 21.7% from Rp42.9
trillion in the previous period)40.
b. Saberpungli
In addition to improve the investment climate in Indonesia, in 2006, GoI has set up a
special task force to tackle Illegal levies named “Saberpungli”. The task force is based
on Presidential Regulation No. 87 Year 2016. Saberpungli was established under the
Coordinating Political, Legal, and Security Affairs Ministry. The units tasks is to
combat illegal levies effectively and efficiently through optimizing the use of
ministries/agencies and government. Whereas, Saberpungli function consists of four:
intelligent service, deterrence, prosecution, and judicial. Two months after it was
established, Saberpungli has received 17,600 reports on illegal fees. Most of the
reports were related to permit issuance, administrative documents, land certificates
and passports. It is too early to call the program is a success. However, the
government is really committed to ending illegal levies.
2. Improving investment climate
a. Infrastructure
Investment-friendly policy packages have been launched to support infrastructure in
Indonesia. First are tax incentives, such as income tax relief for labor-intensive
industries, tax incentives for real estate investment trusts (REITs) and tax incentivesand relaxed regulations on property. Second are business and infrastructure
incentives like those for the footwear and apparel industries, simplification of import
licensing for drugs and raw foods, accelerating infrastructure development, water
management and regulations, dwelling time optimization, oil refinery development,
aviation sector incentives, downstream industries, debt to equity ratio, integrated
logistics zones, CPO funds, support for export-oriented Industries, relaxed cattle
imports, improved ease of doing business ranking, revised DNI and facilitating FDI
and accelerating electricity infrastructure. Last, other incentives, such as the one-map
policy, expansion of coverage and interest subsidies for micro, small and medium
enterprises (MSMEs) are also expected to support infrastructure.
40 https://www.pressreader.com/indonesia/the-jakarta-post/20160816/281784218494007
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108 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
b. Incentive (tax allowance/tax holiday, income tax)
Import duty exemption – Based on Regulation of Ministry of Finance No.
76/PMK.011/2012 jo. No. 176/PMK.011/2009. This incentive focuses on exemption
from import duty on the import of machines, goods and materials for production for a
period of 2 years. The import duty exemption is granted for 2 years based on the
installed machine capacity for production purpose and available for 1 year extension.
If the company uses at least 30% local machineries, import duty exemption is available
for additional product for 4 years. The requirements of this incentive are imported
machine, goods and raw material are: i) Not yet being locally produced; ii) If the local
machines are available, yet unable to fulfill criteria of required machines; iii) If the
local machines are available, yet unable to fulfill the total required machines.
Tax allowance – Based on Government Regulation No. 9 of 2016. The facilities of
tax allowance include: i) Total net income reduction by 30% of the investment, that
are charged respectively 5% per year in the 6 years period; ii) Accelerated depreciation
and amortization; iii) Imposition of income tax on dividends which paid to foreign tax
subject of 10% or a lower rate according to the avoidance of double taxation agreement;
iv) Compensation losses longer than 5 years but not more than 10 years with the certain
conditions (can be seen in the regulation) for the companies that are located in industrial
or bonded zone, developing infrastructure, using at least 70% domestic raw material,
absorbing 500 to 1,000 labors, having Research and Development (R&D) program,
reinvesting capital, exporting at least 30% of selling product.
Tax holiday – Based on Regulation of Ministry of Finance No. 159/PMK.010/2015.
Income tax exemption or Tax Holiday are available for 5 to 15 years and is possible
for the extension up to 20 years under the discretion of Ministry of Finance (MoF).
For Communication, Information and Telecommunication Industry, the value of
investment plan could be lowered from Rp500 billion (34 million EUR) to Rp1
trillion (68 million EUR) for exemption up to 50%. If the investment value exceeds
Rp1 trillion, the exemption is available up to 100%. The decision for Tax Holiday
proposal takes 45 days, with details 25 days at BKPM and 20 days at MoF. If the
proposal is rejected, the company may get Tax Allowance incentive when they fulfill
the criteria stated in Government Regulation No. 18 Year 2015. There are nine types
of industries that are eligible for Tax Holiday: i) Upstream metal industry, ii) Oil
refinery industry, iii) Organic basic chemical industry, based on oil and natural gas,
iv) Machinery industry producing industrial machine, v) Processing industry based
on agriculture, forestry fisheries, vi) Telecommunication, information and
communication equipment industry, vii) Maritime transportation industry, viii)
Processing industry that are main industry in Special Economic Zone , and ix)
Economic infrastructure not in the scheme of government and business project.
c. Revision of Negative List
Revision of Negative List is a revision on list of business fields closed to investment
and business fields open, with condition, to investment. The purposes for the changes
are: i) the achievement of national targets, both economic and infrastructure
development, ii) enhancing the role of domestic and foreign investments in economic
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 109
development, iii) creation of new employment opportunities, iv) increasing value
added and national exports, v) the increase in state revenues.
Due to the revision, Presidential Regulation No. 44 Year 2016 becomes more open
to investments, makes investment process easier, provides more protection to
investor, becomes easier to be understood by the investors, reduces the cost of
logistic, reduces the production cost, supports the creative industry, accommodates
the improvement of the workers.
2.2 Challenges and constraints for Indonesian SMEs to adopt sustainability
standards
Various initiatives have been taken, not only by the government but also by donors, to
encourage the implementation of sustainability standards in business sectors in Indonesia,
including SMEs. The GoI has also made a strong commitment to facilitate sustainable
economy. However, there are many implementing problems to solve. The current incentives
and disincentives for uptake of higher sustainability standards are also less effective. The
following summarizes general challenges for SMEs to adopt sustainability standards and
some specific cases and examples of the challenges.
2.2.1 High costs and difficult procedures of certification process
In order to meet international standard, Indonesian SMEs need to secure several number of
certificates to meet global standards. International Standard Organization (ISO), domestic
timber legality system (SVLK), and Indonesian Sustainable Palm Oil (ISPO) are examples
of certification need to be secured by Indonesian SMEs in order to meet international
standards. However, there are several challenges in securing those certifications. One of the
obstacles is the certification fee. In order to have international standards, Indonesian
business players (including SMEs) must pay expensive costs to secure certificates from
authorities for their businesses. Another obstacle is that the SMEs do not aware of the
benefit of securing those certificates. The SMEs also lack of basic information on how to
apply for those certificates and of institutions that handle the certification processes.
Related to high costs of certification, Indonesia SMEs also have problems with Intellectual
Property Rights (IPRs) certificate. The SMEs are reluctant to apply intellectual property
rights due to their poor information on the IPRs and costly application fee.
2.2.2 Weak motivation to green practice
It could be argued that the activities of most enterprises in Indonesia are still driven by profit
motive, with little concern for the sustainability of their resources. On the one hand,
companies tend to focus on purchasing raw materials and/or intermediate goods at the lowest
cost in order to drive consumption and making the maximum profit for their shareholders. On
the other hand, Indonesian consumers are focusing more on purchasing more affordable goods
and services, which is a common phenomenon in developing countries. Unlike in much
developed countries, eco-branding and eco-label are rarely considered by Indonesia
consumers in choosing products. Only a small part of consumers who are responsible buyers
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110 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
who have high concern for eco-friendly products and care about whether the goods and
services they purchase are processed by following sustainability standards.
2.2.3 Lack of knowledge and transformative capacity to respond to sustainability
standard
Another challenge to implement the sustainability standards is the lack of knowledge and
transformative capacity to respond effectively to sustainability concerns. Schouten,
Vellema, and Wijk (2016) further argue that the transformative capacity in Indonesia largely
depends on its acceptance by and connection with locally constructed rules and practices
directing sustainable change. This raises two questions, i.e. (i) how far a global standard is
flexible enough to align with diversity in local context and (ii) how far the local regulation
and local culture can fit to the global standards.
Producers supply base in Indonesia also have different sizes, are located in different
geographies, with different business models, and with different sources of investment. Due to
this diversity, each producer may respond differently to incentives designed to promote the
spread of sustainability standards. In particular, SMEs may respond and make decisions based
on non-economic factors, such as family, social pressures, or securing tenure/ownership over
land (Gnych, Limberg, & Paoli, 2015). The difference in how to meet the sustainability
standards may cause the marginalization and exclusion of the SMEs. The SMEs also had
limited capital and knowledge of sustainability standards (Mimba, 2012).
2.2.4 Limited connectivity
The Indonesia SMEs awareness to adopt sustainability standard is still low. There are several
reason that caused the awareness in SMEs is still minimum, such as limited connectivity41
and poor education. Asian Development Bank (2015) mentions that connectivity is the second
main factors SMEs to succeed in GVC, after competitiveness. This factor is imperative due
to gain knowledge related to sustainability standard. Asian Development Bank (2015) also
mentions that connectivity will benefit firm to harmonize standards and professional
qualifications (including investment laws and taxation procedures). Firm could also identify
the economic potential and ensuring its resilience to climate change and other risks with
connectivity. Therefore, this condition will depend on critical investments in connectivity.
However, in 2013, there are only 21.98 percent of the Indonesia population were internet
users. This number is quite lower compared to other countries in Asia such as China (50.3),
Malaysia (71.06) and Thailand (39.32)42. Moreover, the average connection speed in
Indonesia in 2015 is about 7.45 megabits per second (mbps). This connection speed is lower
5 megabits per second (mbps) compared to Singapore which was 12.5 megabits per second
(mbps)43.
41 Telecommunications, railroads, highway, airports and seaports are backbones of connectivity.
42 World Bank Data
43 Akamai Technologies, State of the Internet, Q3 2015
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German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 111
2.2.5 High cost of required/certified raw material
National and Indonesian-based multinational firms always hope on raw material availability
in the cities where they operate. In addition, individual SMEs are constrained from obtaining
inputs, such as supplies, raw materials, equipment, technology, skilled labor, and finance,
due to their business size and their isolated/remote location (Abe, 2015). The
environmentally friendly product relative more expensive compared to the non-
environmentally friendly product.
Besides, SMEs also face challenges to secure the raw material, such as uncertainty,
dependency to importers and single partners, as well as fluctuated currency. In addition,
research by BAPENAS found that Indonesian firm experiences that there are limited
availability of domestic raw materials meeting international specifications.
2.2.6 Limited technology to meet the required standards
Generally, technology for green industry is not widely available in the market so requires
innovation that must be done by SMEs. Costs for innovation are often caused high cost
production, thus impact SMEs product become uncompetitive.
Machines are also main part in a production chain for small medium enterprisers to generate
goods. Unfortunately, they were unable to improve quality as machines at factories under
poor condition. Poor machines condition, such as lack of maintenance and old age will
hamper businesspeople to escalate competitiveness
3 SMEs and industry specific profile in Indonesia
3.1 SMEs overview in Indonesia
In Indonesia, the Micro, Small, Medium Enterprises (MSMEs) play a crucial role in the
economy, particularly in employment and economic growth. The term MSMEs is slightly
different to the general definition of SMEs after the implementation of Law of Indonesia No.
20 Year 2008, which adds Micro enterprises the general term. Hence, throughout this paper
the term MSMEs will be referred as SMEs to avoid any inconsistency in using the term.
SMEs represent more than 99% of all enterprises and 96.99% of employment. In 2013,
SMEs were recorded at 57.895 million units, rose by 12.6% (accumulated growth)
compared to five years ago (2008) which was accounted for 51.409 million units (BPS,
2017a). Similarly, the increasing number of employment from 94.024 million people in
2008 to 114.144 million workers in 2013. These figures suggest that SMEs sector is one of
the biggest source of employment, which provides job opportunities to a large proportion
of the Indonesian workforce.
Furthermore, Indonesia’s SMEs are largely scattered in rural areas and are mostly found in
agriculture, trade and manufacturing sector Within these sectors, the majority of enterprises
are privately owned and have the entity status of sole proprietorship of non-legal entity
(World Bank, 2015). This tells us, SMEs are more vulnerable to financing and legal issues
in comparison to those legal entities enteprises. It is worth noting, despite its big
Yose Rizal Damuri / Bagus Santoso
112 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
contribution to the domestic economic growth such as employment and sectoral activities,
SMEs do not contribute as much to the GDP and non-oil export sector, accounted for
approximately 58% and 16% respectively (see Figure 4).
Figure 4: SMEs share of GDP and share of export in non-oil sector (%), 2013
Source: Ministry of Cooperatives and SMEs (2015)
Within a broader context of trade, the particpation of Indonesia’s SMEs in the global market
remains low as indicated by the per cent of firms exporting and per cent of firms using
foreign origin material and supplies. According to the World Bank Enterprise Survey, in
2015 only 7.9% of SMEs exported directly and 5.6% exported indirectly and around 12.3%
used materials and supplies of foreign origin (2015). Similarly, based on the the number of
firms that have international-recognized quality certifications, Indonesia still lags behind
other Asian countries such as China and Thailand as depicted in Figure 5 below. This result
suggests Indonesia SME’s low export prospensity to the global market may be partly due to
its low engagement and compliance with international standards. Low percentage of SMEs
whom are certified at international level suggests there are contributing factors (e.g. practice
of informal sector and financing ability) that may hinder these enterprises from obtaining
international certification,and enabling them to join the global production network.
Figure 5: Sum of percent (%) of firms with internationally-recognized quality certification, 2015
Source: World Bank Enterprise Surveys Data, (2015)
81
64.8
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Large (100+) Medium (20-99) Small (5-19) Average
China
Indonesia
Thailand
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 113
Nonetheless, looking at the growing number of SMEs and its significance contribution to
the economy, Indonesia’s SMEs have much room for expansion and improvement. Though,
due to their characteristics as well as specificities, SMEs often face issues that can hinder
their prospective growth. Some of these issues include limited financial access,
entrepreneurship and technical capacity, low productivity, technology adoption and
standard implementation (Ministry of Cooperative and SMEs, 2015).
In the era of globalization, the proliferation of regional trade agreements imposes new
challenges to the SMEs. Indonesia’s SMEs will not only face stronger competition from
global competitors, but also increase in production costs and implementation of global
sustainability standards and practices. This implies, the exposure to global market and
production network could mean two things: firstly it could enable SMEs to to do economic
and social upgrading which will force SMEs to spur its productivity growth and secondly,
it could possibly intensify the fragile production structure and poor labor and sustainability
condition that has already existed prior to joining the gobal network (Posthuma, 2008).
Thus, it is important for SMEs to have the incentive and the facilitation provided by the
government that will support them to enhance their productivity growth in order to prepare
SMEs to meet these global demands for higher sustainable standards for labor and product
specification.
3.2 Case study I: Indonesia’s specialty coffee industry and its VC position in
global network
3.2.1 Coffee production and export
Indonesia is one of the largest coffee producers and exporters in the world after Brazil,
Vietnam and Columbia. For more than 30 years, Indonesia’s coffee production has shown
an overall positive growth, which expanded rapidly in the last ten years. In 2016, Indonesia’s
coffee production stood at 739.05 thousand tons reaching all-time high. Due to the growing
demand in the global market, Indonesia’s coffee production growth has accelerated, as it is
for other coffee producing countries. Consequently, Indonesia’s coffee export has also
increased, as seen in the figure below.
Figure 6: Coffee production and export, 1990-2016
Source: International Coffee Organization (www.ico.org) and modified by author
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114 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
On average, coffee plantation area in Indonesia is estimated around 1.2 million hectares. In
2016, the coffee plantation area was 1.23 million hectares, which has not much changed in
comparison to a decade ago, estimated at 1.25 million hectares (BPS, 2017b). Most of
plantation area produces three types of coffee, they are Robusta, Arabica, and Liberika coffee.
The Robusta coffee accounts for almost 90% of total production, while the Arabica coffee
and Liberika make up for 10% of production. Similarly, Indonesia’s coffee export mainly
comprises of Robusta coffee (80%) and Arabica and Liberika coffee (20%) (Ministry of
Agriculture, 2015). Large proportion of coffee production is exclusively planted on
smallholders’ land area, which makes up for 96% of total area, which is followed by state-
owned coffee area at 2% and private-owned coffee area 2%.
Moreover, Indonesia’s coffee plantation areas are centered on Sumatera, Sulawesi and Java
island. Robusta coffee is largely produced in Lampung, South Sumatera, Bengkulu, East
Java and West Sumatera, meanwhile Arabica coffee mainly grows in Aceh and North
Sumatera (BPS, 2017b). Although most of coffee plantation produce Robusta coffee, it is
observed that coffee plantation area for Robusta production has shown a decline, while area
for Arabica coffee shown some increase. In 2006, land area for Robusta coffee was
estimated around 1.13 million hectares and fell to 1.04 million hectares in 2011 while land
area for Arabica coffee grew from 177.1 thousands hectares to 251.8 thousands hectares in
2011 (AEKI, 2013). This indicates an increase in Arabica production which may be due to
the increasing demand for specialty coffee from the global market, particularly in developed
countries such as Japan, US and Europe. In addition, based on its product type, there seems
to be a shift in coffee production towards processed coffee and roasted coffee. Depicted
below is Indonesia’s coffee export based on its product type.
Table 3: Export volume based on product type, 2008-2013
Year Green beans Instant coffee Extract, essence, concentrate Roasted coffee
2008 468,018 7,829 15,618 727
2009 510,187 7,200 19,647 708
2010 432,780 7,384 43,870 812
2011 346,091 7,196 69,721 399
2012 447,064 71,685 14,941 1,526
2013 532,157 72,899 10,030 1,867
Source: Association of Indonesia Coffee Exporters (AEKI), 2013
In terms of export value, the overall coffee export’s contribution has increased. In 2000, the
coffee export (FOB) was valued at US$ 339.9 million, and as global demand continued to
grow it increased to US$ 812.3 million in 2010 and US$ 1,189 million in 2015 (BPS,
2017b). The expansion on Indonesia’s coffee production and export has resulted from the
seeming growing demand for coffee globally and domestically. In 2010, global
consumption for coffee was around 6.9 million tons (117 million bags) while this year is
forecast to increase to 9.1 million tons, or 153 million bags. Although coffee consumption
in Indonesia remains low, it has continued to grow, indicated by the consumption per capita
which grew from 0.8 (kg/year) in 2010 to 1.54 (kg/year) in 2016 (ICO, 2017).
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 115
3.2.2 Value chain in coffee industry
Within the Global Value Chain (GVC) context, the position of specialty coffee industry is
depicted in the flowchart above (Figure 7). Similar to other coffee industry (e.g. commercial-
grade coffee), the specialty coffee works under the buyer-driven chain and roaster companies
and large traders/exporters are the leading firms in the functional division of labour within the
chain (Ponte, 2002). Growers, whom are mainly smallholders are responsible for plantation
and production process which includes selective picking, pulping, fermentation, sun drying,
dry hulling, and manual sorting. Coffee production is then collected by green bean traders
who act as collector traders who sell coffee to larger traders/exporters and local roaster
companies. At a global level, coffee are exported to the international markets or can be sold
to roaster companies in the domestic market. In addition, coffee beans from producing
countries undertake an international grading coffee system which is called The Q Coffee
System. It aims to identify the quality of coffee, especially specialty-grade coffee at the
international level. The system allows greater opportunity for growers to obtain a fair market
premium price through high-quality producing coffee.
In the value chain system, growers generally have a close relationshipwith green bean
traders to whom coffee beans are sold to.However, due to the profile of growers and its
characteristics (e.g. low-income family, no education background),it often results in not
only low productivity and low quality of coffee, but also weak bargaining power within the
global system. The collector traders which have higher bargaining power and better access
to the market have more control over economic decision making and production decision
making which prevent them benefiting from the global network. Consequently, growers
face several issues such as limited choice of marketing channels, unfair price system and
market mechanism within the supply chain system (Arifin, 2010).
In addition to producer’s value chain position, growing global initiatives on sustainability
standards and practices have played a role in improving quality of coffee as well as
restructuring supply chain in the global system (Arifin, 2010). Coffee certification systems
such as the Rain Forest Alliance, UTZ Certified and Fair Trade and capacity building
programs for producers are seen as alternative mechanism to improve coffee production and
trade within the value chain system and empower producers especially growers. It allows
exporters and larger traders to have direct relationship in ensuring integrity and high quality
Figure 7: Generalized specialty coffee GVC flowchart in Indonesia
Source: Information gathered during in-depth interview, processed by author
Yose Rizal Damuri / Bagus Santoso
116 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
of product. Such mechanism will encourage improvisation of market structures and price
transparency as well as sustainability practices in the long run.
3.2.3 Regulations and issues
The emerging trend of global sustainability initiatives have pushed traders and exporters
within the value chain system to enforce sustainability standards and environmental practices
in coffee-producing countries. Within the specialty coffee industry itself, there has been an
increasing awareness and market value for “sustainable coffee”(Ponte, 2004) towards
Certification systems becomes a requirement for producing countries by the
exporting/consuming countries to ensure “economic viability” for growers, “environmental
conservation” and “social responsibility”. In Indonesia, the most prominent certifications
include the Utz Certification, Rainforest Alliance, Bird-friendly and Fair Trade.
However, given the raising awareness of sustainability standards and environmental
practices and the growing initiatives for certifications often raised another question for
coffee growers, particularly smallholders. The implementation of global sustainability
standards can often be taxing due to several issues particularly for SMEs. This section will
further discuss about the issues and incentives regarding the adoption of sustainability
standards for SMEs in the coffee industry in Indonesia. The analysis made is based on in-
depth interview with two SMEs coffee and one sustainability coffee platform (NGO).
Issues
1. Profile of coffee producers
Coffee producers in Indonesia comprise of a large proportion (90%) of smallholders. The
majority of these producers come from low income family with low education and skill
background. Without formal and intensive agricultural training, it affects the productivity
and yield of coffee they produce, which often put their production at risk. Other factors
include their weak bargaining position within the value chain system and high dependence
on collector trades exacerbate the existing conditions for producers, especially smallholders.
2. High certification and membership fees
The adoption of sustainability standards require coffee producers to obtain different
certifications, which could be burdensome for most of coffee producers due to its high cost.
Without the financial support from traders or exporters, producers will not be able to afford
such expenses especially given other principle issues they face. According to our interview,
less than 10% of coffee exporters are certified as sustainable. This indicates not enough
incentives for coffee producers and traders to obtain any sustainability certifications.
3. Unawareness towards the importance of sustainability standards
Coffee producers are often unaware of the importance of sustainable and good agricultural
practices. The lack of enforcement and coordination between government and coffee
producers may also contribute to the underlying issue. The adoption of sustainable standards,
which most are voluntary is often only enforced by NGOs and traders/exporters itself.
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 117
4. Lack of transformative capacity to comply
The lack of transformative capacity to comply with sustainability standards can originate
from various factors such as lack of knowledge, technology and the economies of scale.
Within the specialty coffee industry, the adoption of sustainable standards come mostly
from buyers (e.g. local coffee shops, roaster companies).
Incentives
1. Market incentive: higher premium price
The adoption of sustainability standards by coffee producers are incentivized by higher price
offered by traders/exporters. Different pricing scheme can act as an incentive for producers
to produce high quality of coffee. One example is fixed price scheme where buyer sets a
fixed price for coffee product, where buyer is responsible for market risks.
2. Direct trade between coffee traders and producers
The implementation of sustainability standards enforced by the market encourages intensive
and direct interaction between traders and coffee growers within the value chain system. It
allows direct contact between both parties which promotes the principle of traceability. This
acts as an incentive for growers to perform best practice for best quality. In return, the level
of trust built between both parties will translate into fair and direct trade.
3. Formal training and education
Based on our in-depth interviews, the implementation of sustainability standards are taught
by traders through formal training and education. Training on best agricultural practices are
believed to have stronger impact in the long run rather than affording coffee producers
certification and membership fee. Thus, this can serve as an additional incentive for coffee
producers, particularly smallholders to improve their production through better practices
and implementation of labor condition and sustainability standards.
3.3 Case 2: Textile and Products of Textile (TPT) industry and its VC in global network
3.3.1 Textile and Products of Textile production
The Textile and Products of Textile (TPT) has been one of the most important industries in
the Indonesian economy. The industry plays a major role in Indonesia’s employment and as
one of the main non-oil exporting products. During the 1980s, after a series of economic
reforms (e.g. export promotion), concurrent with the declining growth in oil and gas sector,
the TPT industry began to grow rapidly. Until 2011, the textile industry has contributed
significantly to the non-oil gas industrial sector growth, recorded at 7.5% (WTO, 2013).
Figure 8 below depicts the output value of textile industry for the period 2000-2014
measured in IDR billion. Overall, it shows a gradual increase trend, from IDR 98,066 billion
in 2008 which slowdown and plummeted in 2013 before it grew rapidly to IDR 214,966
billion in 2014 (BPS, 2017a).
Yose Rizal Damuri / Bagus Santoso
118 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Figure 8: Output value of textile and products of textilesector, IDR billion, 2000-2014
Source: BPS (2017a)
The Textile and Products of Textile sector has experienced rapid growth ever since the
economic reform took place in 1985. The implementation of reform packages transformed
the trade structure of the sector, in which custom procedures, tariff-barriers and other
restrictive regulations were obliterated. Moreover, as seen in Figure 9 below, the annual
growth of the textile exports continued to rise, despite some minor falls in during the period.
In 2000, Indonesia’s export value was at US$ 7.93 million and US$ 13.3 million respectively
in 2014. Similarly, the overall total import from the textile and apparel sector also increased
corresponding to the growing demand for these productions within the country. Figure 9
depicts it as follows.
Figure 9: Total export and import of Indonesia’s textile industry, 2000–2014
Source: WITS World Bank (2016)
The Textile and Products of Textile sector in Indonesia consists of three sub-sectors:
upstream, mid-stream, and down-stream (Association of Textile Indonesia, 2014). The
upstream sector comprises industry activity at the very beginning level such as natural fiber
and fiber-making. The main characteristic of the sector is capital-intensive. The fiber-making
process requires full automation technology with very large energy absorption. Therefore,
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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
U
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ill
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s
Total Export Total Import
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 119
only small number of labors is required in the fiber making process. Products include
Polyester Staple Fiber and Nylon Filament Yarn. Meanwhile the mid-steam sector is less
capital-intensive and more labor-intensive. The mid-stream sector incorporates spinning,
weaving and knitting activities which manufactures products namely cotton yarn, woven
fabric and knitted fabric. Lastly is the down-stream sector which is full labor-intensive. Over
time, the technology has progressed rapidly in supporting manufacturing activities. The
products such as garment and other textile products are then renovated to finished goods such
as knit and woven garment and bed linen.
The textile sector is a high labor-intensive manufacturing industry relative to other non-oil
manufacturing industry on average. This indicates real productivity changes more often due
to the technological advancement and improved efficiency and productivity. In Indonesia,
the textile industry absorbed quite significant amount of labors although throughout the year
has shown a declining trend in the respective sector. In 2000, the textile industry contributed
around 15% to the total employment for large and medium sector, where it declined to 12%
in 2007 and 11% in 2014 accounted for approximately 546,940 labor unit (BPS, 2017a).
Moreover, looking at the size of the Textile and Products of Textile sector, the majority of
firms are medium and large companies due to the high-profile investment which can only
be accessed in the formal financial market. Similarly, according to BPS (2017a), as of 2014
the number of medium and large firms was recorded at 2555, which has not changed much
in comparison to five years and fifteen years prior which totaled to around 2300 and 2000
medium and large firms respectively.
3.3.2 Value chain in textile industry
Value chain in textile industry is slightly more complex than in coffee industry since it has
longer chain or phase of production. This longer chain creates more opportunities for firms,
especially in developing countries, to participate and give a value added in one of the
production phase. The concept of GVC itself is the processes of production and distribution
which are linked and organized by inter-firm governance across border (Fukunishi, Goto,
& Yamagata, 2013).The characteristic of value chain in textile industry is “buyer-driven
chain”, in which buyers as a lead firms that can be in form of brand owners, brand marketers,
or retailers (OECD, 2013). Moreover, buyers usually set up severalrequirements for firms
regarding product quality, lead time, and compliance with social and environmental
standard (Thomsen, 2007).
The key important things of GVC is to add value in one of the production process and giving
some economic upgrade. For some developing countries, firms usually could join gvc
through labor intensive functions like cutting, making (sewing), and trimming (CMT). CMT
modality usually consist in function that are mostly dependent on low-skill or semi-skill
labor and it is one of lowest value added. For others, they can give more functional value
added in a way business upgrade its position into more complex chain. When sourcing of
input and procurement process functions added to the assembly, it is referred asOriginal
equipment manufacturing (OEM). Furthermore, when firms also have the responsible for
product design it is called Original Design Manufacturing (ODM), and if they also integrate
branding and marketing it is known as original brand-name manufacturing (OBM).
Yose Rizal Damuri / Bagus Santoso
120 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Figure 10: Value chain in textile industry
Source: OECD (2013)
Indonesian textile firms, in their experience entering GVC, always have interaction to
international buyers or third party which is usually called trading agents. Independent
trading agents can be functioned as “hand extension” of international buyers in order to find
garment manufacturer to produce goods ordered with standards that is set by international
buyers. Moreover, trading agents must ensure and check standard quality of products that
are being produced by manufacturer before it comes to the buyers’ hand.
During engagement or interaction process with international buyers, at least there are two
types of agreement or buying practices. First, firms receive an order from international
buyers with all quality standard and brand design set by international buyers. The buyers
usually established liaison offices in that particular country to conduct surveillance on
garment manufacturers, in terms of quality of products and social and environmental
compliance. Transferred knowledge on technical improvement on production, such as
implementing lean production, to shorten delivery time, and improve materials management,
are given by international buyers to increase productivity and lower production cost
(Kadarusman, 2010). Therefore, this relationship is advantageous for both parties. Second,
the relationship scheme where firms only received order from international buyers. With
regards to product quality, design, or even source of input was fully under firms’
responsibility. Neither, buyers do not intervene production’s process, which include labor
standard, social or environmental compliance. This type of scheme usually happens when
firms successfully enter emerging export market such as in Middle East or African countries
and firms could also sell their own brands.
In regards of production process, firms do not always produce all the orders from buyers or
trading agents by their own. Sometimes, large firms search for sub-contractor (usually
smaller garment manufacturer) to help in the production process. In this scheme, large firms
will be a supervisor for the sub-contractorinclusiveness and
coverage of sustainability standard; yet, at the same time, they may endanger the credibility
of standards by both enhancing proliferation and (potentially) watering down standards
requirements. Hence, it is essential that harmonisation initiatives balance the benefits and
perils of standard localisation.
In short, thanks to growing environmental and social awareness among consumers, the
media, and investors, multinational corporations are beginning to perceive sustainability
considerations as a necessity in order to guarantee product quality, their good reputation, and
profitability. It is assumed that sustainability-oriented lead firms push social and
environmental standards across GVCs, which effectively means that SMEs in the supply
chains are required to adhere to these standards. However, transformative effects will only
materialise if proliferation and harmonisation challenges are solved and if sustainability
becomes mainstream in entire industries and sectors. Mainstreaming sustainability standards,
however, requires both credibility of standards through positive social and environmental
effects as well as bearable financial and nonpecuniary burdens for firms in the supply chain
(IAWG, 2011). The latter requirement is briefly sketched in the following section.
Drivers and constraints for adopting sustainability standards in SMEs: introductory chapter
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 7
Opportunities and challenges for small and medium-sized enterprises because of standards
Standards adoption may empower SMEs to access GVCs and export markets and to benefit
from price premiums, increase in sales and more secure markets (e.g. COSA, 2013; ITC,
2016; ITC & EUI, 2016; UNFSS, 2016). Integration into GVCs additionally promotes the
dissemination of knowledge and technology – improving the productivity of SMEs in
developing and emerging countries (ITC & EUI, 2016; UNFSS, 2016). Consequently,
implementation of sustainability standards has the potential to boost SME growth. In
addition, helping SMEs to develop and mature by growing beyond their local market and
into sustainable GVCs, may contribute significantly to widespread, sustainable
development. SME development spurs employment creation and economic growth, as
SMEs form the backbone of the economy accounting for more than half of employment and
more than ninety per cent of businesses worldwide (IFC, 2013) and as SMEs generate the
highest employment growth and the largest share of job creation (Ayyagari, Demirguc-
Kunt, & Maksimovic, 2014).
However, compliance with standards may require changes in the production process and the
technology, which may involve further investments. It may increase production costs and
definitely creates additional costs for certifying or verifying standards compliance (ITC
[International Trade Centre], 2016b). In order to meet standards requirements, SMEs need
to be equipped with both managerial and technological knowledge as well as financing. Yet
SMEs systematically lack capacity, productivity, a trained labour force, and managerial and
entrepreneurial skills. Additionally, half of the small and medium-sized enterprises lack
access to finance with an estimated financing gap of USD 2.1 to 2.6 trillion (Stein, Ardic,
& Hommes, 2013). Hence, the spread of standards could exclude SMEs from international
production and from lucrative markets. In a 2011-survey carried out by the Organisation for
Economic Co-operation and Development (OECD) and the World Trade Organization
(WTO) (2013), lead firms named “meeting standards” as one of the top five barriers for
inclusion of SMEs in GVCs. Concerns about discriminatory effects and standards as
technical barriers to trade have stirred debates whether standards – in particular private
standards – fall under WTO rules (e.g. Thorstensen, Weissinger, & Sun, 2015).
Because of the growing importance of standards and the ambivalent implications for SMEs,
five country case studies have been issued to identify incentives and challenges that SMEs
face in the adoption of sustainability standards. Identifying drivers and constraints for
standards implementation, the case studies also try to understand the link between finance
and sustainability standards. The five country case studies were conducted by local research
partners in the emerging economies of Brazil, China, India, Indonesia, and South Africa
because emerging economies are best suited to analyse drivers and constraints for standards
adoption by SMEs as they have the most conducive quality infrastructure environment for
standards implementation within the developing world. Qualitative findings from key
informant interviews with entrepreneurs and experts from industry associations, standard
organisations, regulators, financial institutions, and/or lead firms are triangulated with
secondary data and available studies to identify the incentives and challenges for SMEs in
standards adoption. The findings were summarised and synthesised in a DIE discussion
paper by Sommer (2017). This collection offers the benefit to make the primary sources, the
country case studies, available in full lengths.
Christoph Sommer
8 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
In the following, the country case studies are presented in alphabetical order. Each case
study comprises of four main elements: an overview of relevant standards in the country
context, an analysis of drivers and constraints for standards adoption among SMEs (with a
zeroing in on one or two selected sectors/industries), an overview of SMEs’ demand for
finance and the link to sustainability standards, as well as policy considerations.
Drivers and constraints for adopting sustainability standards in SMEs: introductory chapter
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 9
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Frankel, T. C. (2017, March 3). Apple cracks down further on cobalt supplier in Congo as child labor persists.
The Washington Post. Retrieved from https://www.washingtonpost.com/news/the-
switch/wp/2017/03/03/apple-cracks-down-further-on-cobalt-supplier-in-congo-as-child-labor-
persists/?utm_term=.d9cf662df46f
Giovannucci, D., von Hagen, O., & Wozniak, J. (2014). Corporate social responsibility and the role of
voluntary sustainability standards. In C. Schmitz-Hoffmann, M. Schmidt, B. Hansmann, & D. Palekhov
(Eds.), Voluntary standard systems : A contribution to sustainable development (pp. 359-384). Springer.
Henson, S., & Humphrey, J. (2009). The impacts of private food safety Standards on the food chain and on
public standard-setting processes. Paper presented at theregarding standard quality products. Small
garment manufacturers or as we can categorize as SMEs have better opportunity joining
global value chain by this kind of format as it is difficult for them to find and connect
themselves into international buyers or even trading agents.
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 121
Figure 11: Mechanism of insertion into value chain
Source: Kadarusman (2010), modified by author
3.3.3 Key issues and recommendation
In Indonesia, issues and challenges that are often encountered by the textile industry mainly
originate from low productivity, high production cost and sustainability standards. The issues
have become major constraints for prospective investors in doing business in the textile
industry. Given the sizeable industry production and growing global and domestic demand,
Indonesia’s textile industry have the potential to expand to meet the global demand. This
section will further discuss about the issues and incentives regarding the adoption of
sustainability standards for SMEs in the textile industry in Indonesia. The analysis made is
based on in-depth interview with medium enterprise and the Indonesia’s association of textile.
Based on our interviews, the sustainability standards are mainly adopted by large and
medium companies and is not an underlying issue within the textile and product of textile
industry. All textile companies comply fully to the compliance/standards imposed by buyers
where the consequences of non-compliant behavior can result in high penalty/claim cost or
termination of contract for the company. In the case for SMEs, they often do not adopt any
sustainability standards because of the inability to meet standards required by buying
agents/global buyers.
That makes SMEs involvement in the GVC is relatively marginal. Not only that SMEs often
do not have access to supply global buyers, they also are not eligible to become suppliers for
Yose Rizal Damuri / Bagus Santoso
122 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
larger companies that participate in the production network due to their inability to adopt
sustainability standards. Those SMEs are only able to have informal contracts with larger
companies, which tend to outsource from SMEs supplier when they face difficulties fulfill
buying orders. Those contracts are often without the consent of buyers or brand’s principals
to avoid sanctions and penalties. Another opportunity for SMEs in the GVC of TPT is to
become suppliers of large companies for their products being sold in emerging markets, such
as Middle Eastern and African markets (Figure 11).
In addition, SMEs in the TPT industry often face difficulties such as lack of skilled labour,
lack of training and education for labours. The lack of government’s involvement in the
provision of formal training is an underlying issue, the company felt needed to be addressed.
The supply chain system does not permit SMEs to have direct access to the global buyers
due to layers of agents and buyers in between. This has resulted in captive relationship
between SMEs suppliers and global buyers within the textile industry. This finding is similar
to a study done by Kadarusman and Nahvi (2013) where it identifies the captive Global
Value Chain (GVC) relationship between suppliers and global buyers through local trade
agents. Hence, the supply chain system does not allow the adoption of sustainability
standards to be fully enforced on SMEs supplier.
4 Financial services for SMEs to integrate into global value chains
Access to finance is a critical part of SMEs development. Chapter 4 will explore on how the
access to financial services can encourage the SMEs in Indonesia to join the GVCs. This
chapter will give an overview of the following topics:
1. Financial services that are demanded by SMEs to integrate into value chains;
2. Specific financial services offered by financial institutions and businesses (including
financial services that are already used by SMEs);
3. Barriers and bottlenecks for SMEs’ access to finance; and
4. Role of sustainability standards in potentially facilitating the access to finance.
4.1 Financial services that are demanded by SMEs to integrate into value chains
SMEs in Indonesia in general need different financing schemes that fit to the nature of their
business. They do not tend to fit to the conventional, branch-based banking practices and
result in low access to finance and low loan share. According to the data of Bank Indonesia
in August 2016, the loan share of SMEs is 19.7 percent, 53 percent of which is disbursed to
trade sector (Rijanto, 2016).
The low access of SMEs to financial services in Indonesia can be analyzed from two
perspectives. From the perspective of financial service providers, serving SMEs is costly,
especially since a high number of SMEs in Indonesia are located in rural areas. In addition,
financial service providers presume that SMEs have high probability of default and lack
necessary and formal requirements to access finance. From the perspective of SMEs, banks’
Drivers and constraints for adopting sustainability standards in SMEs: an Indonesian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 123
financial services do not meet their needs since many SMEs need quick process of loan
application and it is costly to access the financial services. Another overarching issue that
concerns not only financial service providers and SMEs, but also the government and
regulators, is the low level of knowledge on consumer protection.
As the policy to integrate SMEs into GVCs is quite recent in Indonesia, the real need for
specific financial services to integrate into GVCs might be relevant to only a very small
number of SMEs in Indonesia, particularly the export-oriented ones. Out of 57 million
SMEs in Indonesia, there are only 5 thousand SMEs (0.009 percent) that are export-oriented
(Ministry of Cooperatives and SMEs, 2016). Most Indonesian SMEs are serving the
domestic market, which is one of the largest markets in the world.
Therefore, it would seem that the demand of SMEs in Indonesia for financial services is
more related to financing policies that can eliminate the asymmetric information between
financial service providers and SMEs and the provision of affordable and easy-to-access
financial services. These financing policies can directly and indirectly support the SMEs to
integrate into GVCs.
In order to integrate into GVCs, SMEs will require financing sources that can be gained by
providing affordable, suitable, and easy-to-access lending to SMEs; developing systems for
supply chain finance; ensuring trade finance options are available to SMEs; and developing
crowd funding. Additionally, SMEs will need better financial market infrastructure to go
digital and improved financial literacy and consumer protection awareness. Each aspect is
briefly discussed in the following.
4.1.1 Providing affordable, suitable, and easy-to-access lending
SMEs in Indonesia, either the export-oriented SMEs or the domestic-oriented ones, generally
need the provision of affordable funds that are easy to access. This can be provided through
direct mechanism (provision of loan guarantee and offer interest rate subsidy) or indirect yet
potentially more sustainable mechanism such as facilitatingeasier Know Your Customer
(KYC) procedures, reduce asymmetric information between the financial providers and
SMEs, and solve informality issues facing SMEs. Many SMEs in Indonesia prefer informal
loans in lieu of formal loans due to fast procedures, despite significantly higher interest ratesprepared for FAO/WHO.
http://www.fao.org/3/a-i1132e.pdf [31.03.2017]
IAWG (Inter-Agency Working Group). (2011). Promoting standards for responsible investment in value
chains. Report to the G20 High-Level Development Working Group. Retrieved from
http://unctad.org/sections/dite_dir/docs/diae_G20_CSR_Standards_Report_en.pdf
International Finance Corporation. (2013). IFC jobs study: Assessing private sector contributions to job
creation and poverty reduction. Washington, DC: World Bank.
International Trade Centre. (2016). SME competitiveness outlook: Meeting the standard for trade. Geneva:
Author.
International Trade Centre, & European University Institute. (2016). Social and environmental standards:
Contributing to more sustainable value chains. Geneva: ITC.
ISEAL. (2017). What is a sustainability standard? Retrieved from http://www.isealalliance.org/waypoint/what-is-
a-sustainability-standard
Khan, M., Serafeim, G., & Yoon, A. (2016). Corporate sustainability: First evidence on materiality. The
Accounting Review, 91(6), 1697-1724.
Marín-Odio, A. (2014). Global value chains: A case study on Costa Rica.
McKinsey & Company. (2014). Sustainability’s strategic worth: McKinsey Global Survey results.
Nadvi, K., & Wältring, F. (2004). Making sense of global standards. In H. Schmitz (Ed.), Local enterprises in
the global economy: Issues of governance and upgrading. Cheltenham: Edward Elgar.
OECD (Organisation for Economic Co-operation and Development). (2008). Enhancing the role of SMEs in
global value chains. Paris: OECD Publishing.
Christoph Sommer
10 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
OECD, & WTO (World Trade Organization). (2013). Aid for Trade at a Glance 2011: Showing results
emerging from the case stories. Paris: Authors.
OECD, WTO, & World Bank. (2014). Global value chains: Challenges, opportunities, and implications for
policy. Report prepared for submission to the G20 Trade Ministers Meeting Sydney, Australia.
Potts, J., Lynch, M., Wilkings, A., Huppé, G., Cunningham, M., & Voora, V. (2014). The state of sustainability
initiatives review 2014: Standards and the green economy. Winnipeg: International Institute for
Sustainable Development (IISD) and International Institute for Environment and Development (IIED).
PWC. (2014). 17th annual global CEO survey: Business success beyond the short term: CEO perspectives on
sustainability. Author.
Sommer, C. (2017). Drivers and constraints for adopting sustainability standards in small and medium-sized
enterprises (SMEs) (Discussion Paper). Bonn: German Development Institute / Deutsches Institut für
Entwicklungspolitik (DIE).
Stein, P., Ardic, O. P., & Hommes, M. (2013). Closing the credit gap for formal and informal micro, small,
and medium enterprises Washington, DC: International Finance Corporation. Retrieved from
https://www.ifc.org/wps/wcm/connect/4d6e6400416896c09494b79e78015671/Closing+the+Credit+Ga
p+Report-FinalLatest.pdf?MOD=AJPERES
Thorstensen, V., Weissinger, R., & Sun, X. (2015). Private standards – Implications for trade, development,
and governance. E15Initiative. Geneva: International Centre for Trade and Sustainable Development
(ICTSD) and World Economic Forum.
UNFSS (United Nations Forum on Sustainability Standards). (2016). Meeting sustainability goals: Voluntary
sustainability standards and the role of the government. 2nd Flagship Report of the United Nations
Forum on Sustainability Standards (UNFSS). Retrieved from
https://unfss.files.wordpress.com/2016/09/final_unfss-report_28092016.pdf
Drivers and constraints for adopting sustainability standards in SMEs: a Brazilian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 11
I Drivers and constraints for adopting sustainability standards in
small and medium-sized enterprises (SMEs) and the demand for
finance: a Brazilian case study
André Meyer Coelho & Marcelo de Oliveira Nunes, Fundação Getulio Vargas
(FGV)
1 Introduction
The present study is based in primary and secondary research and fosters the current levels
of sustainability adopted by SME in Brazil, its drivers and constraints as well as the need
for a deeper approach from either governance or financial support. A broader approach on
the use of standards will also be part of the text. Among the findings, it is clear that there is
a strong need for two major issues in Brazil: Sustainability standards governance and
financial structure. In the first perspective, the way that different strategies influence social
and economic behaviour should be undertaken in order to achieve the communities’ goals.
For the second mentioned, not only state-run actions should be acknowledged, but also
measures created by other organisations – “including corporations, self-regulators,
professional or trade bodies, and voluntary organizations”.
Currently, a “smart” regulatory framework is in place among value chains and suppliers,
what boosts opportunities for cooperation among different stakeholders, in order to develop
a model where public welfare can effectively be created, by taking advantage of the diversity
of views and instruments. However, without a national focused plan, the potential for SMEs
to actually jump into this trend is put at risk. It is estimated that Brazil has about 11 million
Small and Medium-sized enterprises (SMEs)2 currently in operation, which accounts for a
considerable portion of the economic activity in the country. SMEs’ contribute to 27% of
Brazil’s GDP, and are responsible for 52% of the country’s legal workforce.
In 2015, 12,163 SMEs exported to international markets3, out of which 5,360 were small
enterprises and 6,803 medium-sized enterprises. That accounts for 61% of the total number
of export companies in the country in that year, and represents an increase of 8.6% in
comparison to the previous year. As for the absolute values, SMEs exported US$1.97 billion
in 2015, 1.6% less than 2014. This amount represents 1.03% of the total national value
exported in 2015.
There has been an increase of manufacturing and industrial SMEs among the exporting
companies. The main manufacturing products identified were: footwear, marble and granite
derivatives, processed timber, instruments for measurement and verification, women’s
clothing and furniture in general. About 44% of the total Brazilian SMEs exports were
bound to South America, especially Mercosul countries, such as: Argentina, Chile and
2 https://www.sebrae.com.br/sites/PortalSebrae/ufs/mt/noticias/micro-e-pequenas-empresas-geram-27-
do-pib-do-brasil,ad0fc70646467410VgnVCM2000003c74010aRCRD
3 http://www.bibliotecas.sebrae.com.br/chronus/ARQUIVOS_CHRONUS/bds/bds.nsf/55ba13f77
c84abe6b2cca37e46909190/$File/7484.pdf
André Meyer Coelho / Marcelo de Oliveira Nunes
12 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Uruguay. In second place, two markets evenly account for SMEs’ exports, in one side EU
(16.5%) and in the other side USA and Canada (16%).
2 Methodology
This study was conducted under 3 methodological steps. The first was based on secondary
documental research, the second on primary interviews with high level professionals in
private and public sectors, and, the third, an analytical interpretation based on the results
found.
The secondary research was mainly conducted using government publications, as well as
public documents and scientific papers highlighting the use of sustainability standards
among companies in all levels of productivity in Brazil. A specific approach has been given
to SMEs and the supply chains of national and international value chains. The results were
broad and showed the need to an adjustment in the general understanding about the use of
sustainability standards inthe Brazilian production system (primary or secondary) and
service provision. Therefore, a need for direct primary interviews was clear.
The second part of the study involved interviews with relevant stakeholders that are either
in the ruling sector of Brazil or in the operational activities, making it possible to understand
all levels of sustainability standards use and regulations. Additionally, members of
academia (professors and researchers), whose body of scientific production focused in
SMEs and the adoption of sustainable practices, have also been contacted and interviewed.
Finally, in the analysis of the material collected, two things became clear: (1) the different
approaches to drivers and constraints in multiple sectors, which can be understood by the
emergence of a diverse number of such opportunities and barriers; and (2) the different
levels of importance of each factor, which urged for a ranking. Thus, in the presentation of
these elements, readers will find those recurrent in multiple industries and activities, as well
as a comprehensive hierarchy among them.
3 Overview of standards
The idea that sustainability is a complex theme is still in the mind of some regulators and
private managers. On the other hand, most of the companies have already acknowledged
that it is more than merely “red light” actions, which means that much more can be done
than just restrict behaviours and prevent undesirable activities. It is feasible to develop
policies that would enable, or at least facilitate, the flourishing of values through a “green
light” approach. In sum, not only is it important to develop measures to restrict
unsustainable behaviours, but it is also necessary to create opportunities to the development
of public goods (funds, technical assistant, capacity building, etc). By cleverly taking
advantage of green regulatory approaches, it is possible to handle policy issues with a
variety of tools and, consequently, look forward to better outcomes.
Along these lines, companies that manage natural resources, operate or deal with potentially
harmful activities are demanded to comply with Brazilian environmental standards. Law on
Drivers and constraints for adopting sustainability standards in SMEs: a Brazilian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 13
three administrative levels regulates these standards and, in some cases, special
authorisations are needed for the company to start its operations. In the Federal level,
licences are regulated by Law #6.938/81 (complemented by law #140/2011) and
CONAMA4 Resolutions #001/86 and #237/97. Companies need to issue their federal
licences with IBAMA5 whenever the project implicates the exploitation of forests or any
biome altering, or when national Conservation Units are involved.
Whenever the endeavour’s impacts are limited to a specific Brazilian state, or to an area
broader than a municipality, environmental licences are granted by the specific State’s
Board for Environmental Issues. Each board adopts different standards, following Brazil’s
commitment to the federative principle. The state of São Paulo, for example, has recently
passed a bill to simplify the process of licencing. Through the Decree # 60.329/2014,
companies that have a lower environmental impact, such as SMEs, may issue the three
necessary licences at once, and by means of an online system.
If the project has merely local potential impacts, then the entrepreneur must address the
municipal Board for Environmental Issues solely, which will provide specific guidelines
depending on the type of company. In Rio de Janeiro city, for instance, Law # 1.618/1990
regulates the penalties that polluting companies are subject to when they do not comply with
standards, and law # 4.969/2008 establishes instruments, principles and goals for the
integrated management of solid waste in the city, including those produced by SMEs.
As a rule of thumb, federal and state licences are issued on a three-step process. Firstly, the
entrepreneur issues the “Licença Prévia”, or Preliminary Licence, which establishes the
specific requirements that needs to be fulfilled by the project, once its conception and location
have been approved. In this stage, special studies and reports on environmental impacts may
be demanded or not. Secondly, the authorization for the company to establish itself is provided
by the “Licença de Instalação”, or Installation Licence. At this point, the public organisation
in charge indicates environmental quality patterns that must be addresses by the company, as
well as its control mechanisms during the implementation process.
The final authorization necessary to start the company’s operation is granted by the “Licença
de Operação”, or Operation Licence, once it is verified that the company has complied with
all standards from previous stages. In order to maintain the final licence (which is valid from
4 to 10 years) the company must keep track of the operational goals set by it, in terms of
minimizing its impacts. It is worth mention that the SME itself, is the sole responsible for
all impact studies, payments and tariffs involved in obtaining these licences.
In addition to the environmental licences aforementioned, two other types of authorisations
may apply. Whenever the activity implicates vegetation suppression, a specific
authorisation must be issued with the corresponding state’s environment board, thus
observing the new Brazilian Forest Code (Law #12.651/2012) and Conama Resolution
#428/2010. On the other hand, if the activity requires underground or surface water
catchment as an input for production or delivery of the service, the entrepreneur needs to
issue a bestowal for the right to use it. The authorisation is also usually granted by the state
board, in accordance to the National Policy for Hydric Resources (Law #9.433/97).
4 CONAMA: National Environment Council
5 IBAMA: Brazilian Institute of Environment and Renewable Natural Resources
André Meyer Coelho / Marcelo de Oliveira Nunes
14 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Together, there are about 155 mandatory standards according to Inmetro, and about 80% of
these refer to sustainable practices. As for voluntary standards, according to the Brazilian
Association for Technical Norms (ABNT)6, there is a total of 7,822 on the list. The most
prominent sustainability certifications across SMEs in Brazil are within the ISO series.
Typically, the ISO 14.001 series is the most well known and more often demanded by larger
companies in all industries to their suppliers. Depending on the sector, especially within the
timber value chain, additional certificates like FSC and Fairtrade are also usually in order
for SMEs to comply.
In the past few years, due to local governmental initiatives in some Brazilian states, like Rio
de Janeiro, São Paulo and Pernambuco, there has been an increase in relevance of
certifications concerning greenhouse effect gas emission. These states have approved
legislation requiring stronger commitment by companies concerning the report on emissions,
which is the subject of ISO 14.064, for example, and therefore the demand for this certification
has increased.
It is worth mention that most of these standards are sought by SMEs as they engage in Global
Value Chains, due to the fact that the domestic market for certified products is still to be
further developed. That helps explain the reason for national certification seals to be still in
its infant stage, making room for the prominence of international types of standards, which
are a prerequisites imposed by lead companies, in order to buy from local suppliers. A better
overview on the relevance of these standards may be seen in thesectors analysis below.
3.1 Industry sector
The typical sectors in which Brazilian SMEs activities are worthy of specific regulation are
within the industry and agribusiness, even though some services may be subject as well. In
the industry sector, the Construction value chain is a common example of activity that
demands a large number of smaller suppliers, who handle or transform potentially harmful
raw materials, such as timber, iron and metals in general. Construction waste management
is regulated by specific resolutions from the National Environment Council – CONAMA:
Resolutions #307/2002, #431/2011 and #448/2012.
Voluntary standards concerning energy efficiency in Construction are provided by Procel7
through its “Selo Procel Edificações”. It is estimated that the residency and commercial
buildings’ energy consumption represents about 50% of the total energy demanded in
Brazil. Thus, this program grants certification for building projects that prioritise wrapping
techniques, illumination and water boiling systems, in addition to air conditioning systems
that are more eco-efficient8.
Broader voluntary standards recognition is granted by Fundação Vanzolini9 that represents
the HQE (Haute Qualité Environnementale) process in Brazil. The foundation developed
6 http://www.abnt.org.br/normalizacao/numeros-2016
7 Procel: National Program for Conservation of Electric Energy
8 http://www.eletrobras.com/pci/main.asp?View={89E211C6-61C2-499A-A791-DACD33A348F3}
9 http://vanzolini.org.br/aqua/certifique-o-seu-empreendimento/
Drivers and constraints for adopting sustainability standards in SMEs: a Brazilian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 15
the AQUA – Alta Qualidade Ambiental certificate, which evaluates 14 enterprise
environmental quality categories, such as water, energy and waste management, visual and
acoustic comfort and sanitary quality of the construction project.
Finally, Caixa Econômica Federal10, a government bank, provides the “Selo Casa Azul” for
those housing projects that comply with socio-environmental standards organised in 6
categories, such as: urban quality, project and comfort, energy efficiency, resources
conservation, water management and social practices. It is worth mention that because this
certificate is granted by a public bank, it is also a prerequisite to access some financial lines
in this bank, that is considered a reference for construction credit in Brasil.
3.2 Agribusiness
Advancing to agribusiness activities, one of the first concerns entrepreneurs must have is to
fill out the CAR – Cadastro Ambiental Rural11, a mandatory registration for all rural
properties with the Brazilian Ministry of Environment database. This registration12 entitles
SMEs in rural areas to access federal programs and development projects, access special
financing lines from banks, tax incentives on production inputs, let alone the ability to
commercialise environment reserve quotes and compensations for other rural properties,
among other kinds of advantages. Nonetheless, the registration in the CAR system is only
the first step towards obtaining many of these benefits, which does not exclude the necessity
for the SME to pursue additional suitability for each specific program.
Agribusiness entrepreneurs also need to observe sanitary legislation concerning their
activity. Such adequacy was considered as time-consuming and expensive until the creation
of the SUASA – Sistema Unificado de Atenção à Sanidade Agropecuária13. This system is
turning the sanitary registration process for SMEs less bureaucratic and demanding when
compared to the past, when they needed to comply with the same standards as big
agribusinesses. It does that by decentralising and unifying the sanitary registration process
for agro SMEs, which become eligible to offer their products to other states within the
country, and not only locally.
As far as Voluntary Standards go, there has been a growing interest for organic production
in agribusiness. The Orgânicos do Brasil14 certificate is granted for farms that minimise their
environmental impacts, by banishing the use of pesticides and synthetic fertilisers for
example, but at the same time, are able to comply with labour legislation and other social
premises. The certificate is extended to industries that obtain their inputs from organic farms
and, thus, utilise at least 95% of organic inputs in their production process. Annual fees may
vary from R$2,500 to R$15,000 depending on the complexity of the project, and companies
must be audited on a yearly basis.
10 http://www.caixa.gov.br/sustentabilidade/produtos-servicos/selo-casa-azul/Paginas/default.aspx
11 CAR: Rural Environmental Registration
12 http://www.car.gov.br/#/sobre
13 SUASA: Unified Care System for the Agro Sanity
14 http://ibd.com.br/pt/Default.aspx
André Meyer Coelho / Marcelo de Oliveira Nunes
16 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
Another example of Voluntary Sustainability Standards in agribusiness is the CERFLOR –
Programa Brasileiro de Certificação Florestal certification. It is granted by INMETRO15 to
farms that either handles forest stewardship or industries prone to work with certified timber
in their productive process. It adopts about the same policies as the PEFC – Programme for
the Endorsement of Forest Certification.
As far as international VSS go (e.g. Fairtrade, FSC, PEFC) it became clear along the course
of the present study that in the large majority of the cases, SMEs and small rural producers
tend to seek them only as a means to sell to big multinational companies. Very rarely do
small Brazilian companies issue international certifications if they aim the domestic/local
markets. If we consider that less than 1% of the total of SMEs are engaged in GVC, it
becomes clear how limited this pool is in the whole scenario.
4 Drivers and constraints analysis
In this section, we will provide an overview of the main topics arisen during the specialists’
conversations, in combination with those identified in the review of studies and previous
publications about the Brazilian scenario on SMEs’ adoption of sustainability standards.
Some of these topics may not be exclusive national characteristics, but when seen in
combination they build the expected portray of the country’s reality.
The analysis as follows refers mainly to opportunities and bottlenecks that may be faced by
SMEs who are engaging in export activities, and therefore need to comply with certification
demands as part of Global Value Chains. However, as the present research unfolded, an a
priori analysis of reasons and limitations for SMEs to adopt sustainable practices in general
seemed invaluable to understand the problematic in a broader perspective.
Broadly speaking, we can say that the main drivers associated with the adoption of
sustainability practices by Brazilian SMEs are the possibility to increase efficiency, and the
adequacy to legal regulations. At first, a number of simple practices such as recycling,
resource rationalisation and energy saving may be seen by the SME as less demanding in
terms of investments, and bearing the potential to provide short term operational results. As
engagement in these activities progresses, other initiatives take place like the acquisition of
new more efficient machinery and the installation of greener energy supply systems, like
solar panels for example, which may have longer payback periods.
Secondly, when talking about environmental and labour regulation, SMEs, especially those
that handle natural resources, tend to be more sensitive to comply with federal and local
laws in order to avoid regulatory retaliations.Also, some domestic opportunities may unfold
because of that, in the form of government procurement, as public institutions in Brazil are
forced by law to hire suppliers that audit their social and environmental practices16.
15 INMETRO: National Institute of Metrology, Quality and Technology
16 Just to give an idea of the size of this market, in 2013, SMEs represented 57% of the R$40 million spent by
the federal government on public purchases, and this trend should increase according to
specialists.Source:http://sustentabilidade.sebrae.com.br/Sustentabilidade/Para%20sua%20empresa/Estudos%
20e%20Pesquisas/CSS%20-%20estudo%20-%20tend%C3%AAncias%20de%20sustentabilidade.pdf
Drivers and constraints for adopting sustainability standards in SMEs: a Brazilian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 17
One interesting finding of the present study is that, unlike what one could expect based on
other national contexts, environmental awareness was not mentioned by specialists as a
main driver. It is not the same as to say that there is little or no concern on the entrepreneurs’
side to voluntarily engage in practices that are more responsible. However, when analysing
the primary motivational factors, the concern with environmental and social sustainability
per se is not sufficient to be translated into behaviours and make actual changes in the
companies’ activities impacts. Especially if the SMEs’ market is mainly local or domestic.
As for the a priori constraints for the adoption of sustainability practices, three main factors
have been identified: the lack of information, the perception of high costs and the access to
finance. Many entrepreneurs fail to realise that adopting sustainable practices may be
beneficial to his/her business in several ways, while others have not even come across this
topic yet, as if all the imperatives about sustainability in the international level were too distant
from SMEs. Also, there is a widespread misperception that sustainability is a synonym for
expenses, as if there were no leveraging opportunities associated with it. Finally, small
companies that make past these first barriers concerning misinformation, and understand the
importance of sustainable practices, may lack the necessary initial investments to adopt them.
As previously argued, the aforementioned opportunities and bottlenecks help build a
broader comprehension on a priori factors that comprise the general mind-set of Brazilian
SMEs concerning sustainable practices. Some of these factors relate to the upcoming
analysis of drivers and constraints in GVC, which should be further discussed as follows.
4.1 Drivers to adopt sustainability standards
A) Access to new markets
According to standards institutions in Brazil, SMEs typically engage in a certification
process due to a pre-existing or a potential opportunity to take part in a GVC. In these cases,
SMEs are forced to comply with standards in order to access these markets, which leaves
them with little choice if this is their goal. In a lesser extent, small companies may commit
to a certification process when they target the domestic market. Some of the examples seen
to have increased in the past few years include B2B markets like printing (print shops) and
coffee roasting, as well as the organic food consumer market as a whole.
Along these lines, in the specialists’ view, the possibility to develop international demand
is a key strategy for SMEs in the current scenario of economic recession the country is
experiencing. To illustrate this trend, there has been an 11.44% increase of export SMEs
from 2013 to 2015, which highlights the attempt of these companies to diversify their
demand and at the same time be granted with better security, with fixed contracts.
In addition to the aforementioned economic reasons to integrate a larger company’s supply
chain, SMEs seek innovation opportunities. As they became part of the GVC, it becomes
easier to disseminate managerial practices that will improve the SME’s productivity and
competitiveness, which otherwise would require more time and effort to develop in an
independent manner. Also, when they need to audit their production to acquire a certification,
specialists say this is an opportunity to better organise and improve their productive systems.
André Meyer Coelho / Marcelo de Oliveira Nunes
18 German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE)
B) External support
SMEs seldom manage to go through the whole process of certification on their own. As a
means to bridge this gap, the small company may either be aided by the lead company in
the GVC (by means of supplier development programs) or by supporting agencies like
Sebrae. Sebrae is the most prominent reference for small entrepreneurs in Brazil, as they
provide training and consulting focused in SMEs at affordable prices. They also provide
financing access both by its own funds targeted to innovation projects (which also covers
sustainability initiatives), and through acting as an intermediary between SMEs and banks.
In some cases, e.g. small rural producers, the ones who lack more qualification and
resources, the lead company itself may subsidise the certification process. This subsidy may
be full-expense, or a partial coverage, usually tied to better negotiable prices, which
increases the lead company’s bargain power. These suppliers usually are certified in group,
which makes it more viable by means of cooperation.
C) Social and environmental awareness
SMEs’ management is too centred in the manager or entrepreneur’s figure. So, if the
manager considers sustainability to be a relevant issue, this topic will somehow make its
way into the company’s strategic planning. Specialists were consensual to claim that there
is a new generation of entrepreneurs who have a higher level of environmental and social
awareness, but this trait is harder to find in more traditional businesses. This trend is usually
pulled by the awareness of the domestic consumer market as well, which is still non-
significant in the country, and too centred in high-income, urban, upper classes segments.
Another process associated is the fact that as SMEs begin to engage in rather basic
sustainable practices, other possibilities may unfold. One of the specialists claimed that it is
not rare to find SMEs that begin by adopting cost-efficiency types of practices, for example,
and when they realise the importance of such initiatives on the environmental side, they
move on to engage more thoroughly in social actions too. Some examples are the promotion
of incentive programs for workers, improvement of the relationship with local communities
and the promotion of a gender equality mentality throughout the organisation’s culture.
D) Level of internal bureaucracy
SMEs typically show a lower degree of internal bureaucracy, which allows them to adopt new
practices without having to go through several departments or managerial levels until they are
approved. Due to the lower amount of employees and managers, internal communication
tends to be easier, allowing it to be more fluid and helping spread the benefits of being
certified.
4.2 Constraints to adopt sustainability standards
If in one hand enterprise do see advantages to adopt sustainability standards, on the other
hand there are several issues that pull them back in terms of expectancies to a more
sustainable business development.
Drivers and constraints for adopting sustainability standards in SMEs: a Brazilian case study
German Development Institute / Deutsches Institut für Entwicklungspolitik (DIE) 19
A) High costs
The adoption of standards is considered an expensive process in Brazil, and therefore not
many companies can afford it,Mais conteúdos dessa disciplina
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